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and the International Monetary System Rapporteur: André Astrow

Gold and the International Monetary System

A Report by the Chatham House Gold Taskforce Rapporteur: André Astrow

ISBN 9781862032606 Chatham House, 10 St James’s Square, SW1Y 4LE T: +44 (0)20 7957 5700 E: [email protected] www.chathamhouse.org F: +44 (0)20 7957 5710 www.chathamhouse.org Charity Registration Number: 208223

9 781862 032606 Gold and the International Monetary System

A Report by the Chatham House Gold Taskforce Rapporteur: André Astrow

February 2012

www.chathamhouse.org Chatham House has been the home of the Royal Institute of International Affairs for ninety years. Our mission is to be a world-leading source of independent analysis, informed debate and influential ideas on how to build a prosperous and secure world for all.

© The Royal Institute of International Affairs, 2012

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www.chathamhouse.org Contents

The Chatham House Gold Taskforce iv Preface and Acknowledgments v Executive Summary vii

1 Introduction 1 1.1 The international monetary system under scrutiny 1 1.2 The return of the gold debate 2 1.3 The Chatham House Gold Taskforce and the goals of the report 4

2 From the Collapse of the to the Demise of Bretton Woods 6 2.1 Why did the Gold Standard fail? 6 2.2 The rise and fall of Bretton Woods 7 2.3 After Bretton Woods 8

3 Current Challenges for the International Monetary System 10 3.1 The world economy in transition 10 3.2 The buck stops here? 11 3.3 The rise of the renminbi 12

4 Is There a Role for Gold? 15 4.1 Benefits and costs of reintroducing gold in the international monetary system 15 4.2 Gold as an anchor 16 4.3 Gold as a hedge or safe haven 19 4.4 Gold as collateral 26 4.5 Gold as a policy indicator 26

5 Taskforce Conclusions 28

References 30 Appendix 1: About the Taskforce Members 33 Appendix 2: Taskforce Meeting Agendas 36

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www.chathamhouse.org The Chatham House Gold Taskforce

Bill Allen Visiting Senior Fellow, Faculty of Finance, Cass Business School, City University London and a specialist adviser to the House of Commons Treasury committee Forrest Capie Emeritus Professor, CASS Business School, City University London Meghnad Desai Em eritus Professor, London School of Economics Gail Fosler President, GailFosler Group LLC Haihong Gao Director, Research Center for International Finance, Chinese Academy of Social Sciences (CASS) John Gault President, John Gault SA Gerard Lyons C hief Economist and Group Head of Global Research, Standard Chartered Catherine Schenk Professor of International Economic History, University of Glasgow Paola Subacchi R esearch Director, , Chatham House Michael Wong Chairman, CTRISKS

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www.chathamhouse.org organizations, private financial institutions and academia from across the world. Taskforce members attended a number of research discussions held at Chatham House and regularly exchanged views by email. The work of the Gold Taskforce is summarized in this Preface and report by André Astrow, the Taskforce rapporteur, who faced the herculean task of bringing together members’ Acknowledgments direct input and reporting their collective, if not specific, views on the topic. The report is an imperfect attempt to distil the richness of the debate in which the Taskforce members have been engaged. Being aware of this intrinsic limitation, the Taskforce members have agreed to make their individual written contributions and presentations Since the 1930s, when Chatham House (the Royal Institute available to interested readers on the Chatham House of International Affairs) convened an International Gold website. Problem Study Group, the international monetary system This report is an important contribution to the debate has always been at the of our work. In 2010 on the international monetary system as it provides an the Chatham House report Beyond the Dollar set out independent and unbiased assessment of the benefits some of the ideas that then fed into the agenda of the and limitations of gold. It would not have been possible G20 working group on the reform of the international without the commitment and support of many people monetary system in 2011. In late 2010, partly prompted and organizations. by an article by Robert Zoellick the president of the My thanks go above all to the members of the Taskforce World Bank, in the Financial Times, and partly because (listed on page iv), who gave so much of their time over we felt that the discussion on Special Drawing Rights the course of this project. Members participated in a series in Beyond the Dollar did not extend to an assessment of three external consultation meetings and three study of the role of gold in the basket, we believed that it was groups from March 2011 to November 2011 to discuss time to address in an unbiased and independent way the the role of gold in the international monetary system. A question of whether there is a role for gold in the inter- number of them offered papers and presentations whose national monetary system. ideas were then incorporated in the report. All Taskforce We decided that the best way to address this broad members provided substantive content, data and amend- question was to convene a commission of experts from ments to various drafts of the text and charts. different backgrounds – academia, central banks, the I would like to thank Dr DeAnne Julius, chairman private sector – and different nationalities in order to of Chatham House, for her enthusiastic support for the encourage a more rounded discussion. The Chatham project. Despite being unable to serve on the Taskforce House Gold Taskforce came to life in March 2011 and owing to personal commitments, she provided timely spent almost a year analysing existing research, with advice and expertise, and acted as an important point of members producing their own research to support its reference for the whole project. work and debating many aspects of gold as an element of On behalf of Chatham House, I thank all those organi- the international monetary system. Through this period zations that in different ways supported the work of the the Taskforce was engaged in external consultations (see Taskforce, in particular the Chinese Academy of Social Appendix 2 for the agendas of those meetings) as well Sciences (CASS), and Professor Yu Yongding and Mr as one-to-one discussions with external experts, seeking Zhang Yuyan. We hope that this report does justice to the v views on the topic from the public sector, international confidence they placed in us.

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I also wish to thank the participants in the three external Research Assistant, provided vital research support across consultations we held in Washington DC, London and a range of complex topics and sources. Jamie Cirrito, Beijing (detailed in Appendix 2). International Economics Administrator, coordinated the Special thanks go to our rapporteur André Astrow, for logistics for all meetings related to this project. Margaret so admirably capturing the sense of the Taskforce's work May, Chatham House Publications Editor, oversaw the and summarizing its conclusions, dedicatedly working editing and the whole publication process as effectively through several drafts of the report to ensure that all as always. The Chatham House Communications team nuances were depicted and each member of the Taskforce was prompt as ever to respond to all media queries about felt that his or her views were correctly represented. the topic. This report would not have been possible without the Finally, I should also thank Benjamin J. Cohen and John contributions of a number of Chatham House staff, to Nugée and two anonymous reviewers for very helpful whom I am very grateful. Nick Maxwell, Programme and comments on drafts of the report. Outreach Manager, led this project from its beginning almost to its completion when he left Chatham House on Paola Subacchi a year’s leave to serve as a member of the UK Territorial Research Director, International Economics, Army. Richard Varghese, International Economics Chatham House

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www.chathamhouse.org carefully assessed in what way bullion could make a positive contribution through intellectually grounded analysis and discussion. In particular, the aim was to fill a gap in the debate on the pros and cons of a fiat money- based international monetary system versus one anchored Executive Summary or partially anchored by gold. In evaluating the advantages and disadvantages of rein- troducing the use of gold in the international monetary system, the Taskforce was fully cognizant of the serious drawbacks of bullion that had led to the demise of the Gold Standard era in the 1930s and the abandonment of In 2011 Chatham House set up a global Taskforce of the Bretton Woods arrangement in 1971. Nonetheless, experts to assess what role, if any, gold could play in the the Taskforce was also sufficiently captivated by the international monetary system in the wake of the current positive attributes of gold, such as its lack of credit risk financial crisis. Despite widespread concerns with the and rich historical importance, to believe the role of gold performance of the system in recent years, repeated calls merited a comprehensive new look within the framework by policy-makers across the world for the implementa- of reform. tion of far-reaching reforms to the post-Bretton Woods The Taskforce focused its attention on four distinct framework have produced few tangible results. A number frameworks for reintroducing an element of gold as a of influential policy-makers have made allusions to the fact means of enhancing the performance of the international that gold could perhaps once again play a useful role in the monetary system. It investigated the role gold could play: international monetary system, but very rarely has bullion featured as a central element in conventional research or • as an anchor; policy discussions. • as a hedge or safe haven; To help fill this void and contribute to the ongoing • as collateral or guarantee; debate about reform, the Chatham House Taskforce took • as a policy indicator. a fresh and open-minded approach to the different ways gold could be used within the international monetary In addition, the Taskforce debated the pros and cons of system. The Taskforce carried out the first in-depth potentially including gold in an expanded basket examination of all the different suggested roles for gold of the International Monetary Fund’s Special Drawing in nearly 30 years. Not since the 1982 US Commission Rights (SDRs), an international reserve asset created by on the Role of Gold in the Domestic and International the Fund in 1969 which some view as a possible replace- Monetary Systems was bullion discussed in such a ment for the US dollar in its capacity as the primary global comprehensive fashion by a prominent policy group of reserve currency. experts. Lastly, the Taskforce considered the possible role of Given that discussions on the role of gold often trigger ‘digital gold’ in a rapidly evolving international monetary strong emotions and reveal existing prejudices across system which some gold analysts believe could offer a the policy spectrum, the Taskforce was keen to take as viable alternative to fiat . its starting point the perspective that this was a subject Although Taskforce members refrained from making deserving of serious and level-headed analysis. Far from specific proposals or recommendations regarding a dismissing the view that gold might somehow once again possible comeback for gold, their debates and research play a key role in the international monetary system as generated a number of compelling and stimulating conclu- vii the misguided belief of a few gold analysts, the Taskforce sions. Key findings include:

www.chathamhouse.org Gold and the International Monetary System

• The lessons of both the Gold Standard era and the circumstances. In so far as increased gold reserves the post-war Bretton Woods period suggest that reflect a desire for more discipline, it does have a narrow re­introducing gold as an anchor would undoubtedly indicator role to play, but from the research examined be impractical or even damaging, given bullion’s defla- by the Taskforce there appears to be no consistent and tionary bias. reliable correlation between bullion and a large number • Gold has a role to play as a reserve asset for central of key economic variables that could be employed to banks. This is evident from the recent behaviour of inform policy decision-making more effectively. central banks in developing countries, and from the • The Taskforce determined there was little evidence fact that gold still accounts for a significant percentage that expanding the SDR basket to include gold of reserves in a number of developed economies. would be effective in strengthening the international Gold can serve as a hedge against declining values of monetary system. Although the inclusion of curren- key fiat currencies, and can also be useful for central cies from key developing countries such as banks looking to diversify their foreign reserves. would be a positive step for SDRs to better reflect their However, its role as a hedge is not cost-free. Indeed, growing importance in the global economy, there was one major downside of holding gold is that its price less evidence to suggest that incorporating gold into can be volatile compared with other reserve assets. the basket would be beneficial. Another is that it generates no yield, other than gains, which are only realized when it is sold. Gold As the world becomes increasingly multi-polar, inter- can therefore have some utility in a portfolio of assets dependence becomes the rule, and the dominance of the by spreading valuation risk, but would not be very is steadily challenged, the global economy effective as a sole reserve asset. can be expected to suffer from bouts of great volatility • The jury is still out on whether gold could play a more and uncertainty. In such an environment, gold is likely to significant role in the international monetary system continue playing a useful role as an effective hedge and safe by serving as a policy indicator for monetary or fiscal haven. But, despite gold’s positive attributes, the evidence policy. Since the early days of the financial crisis, the which emerged from the Taskforce’s deliberations led to sharp rise in the price of gold would have been thought the conclusion that, in today’s world, there is little scope by policy-makers to indicate the need for tighter for gold to play a more formal role in the international policies, which would have been highly damaging in monetary system.

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www.chathamhouse.org varying degrees of control over exchange rates and cross- border flows, today’s international monetary system has been described by the International Monetary Fund (IMF) as something of a ‘non-system’.3 As the Fund has 1. Introduction put it, the current non-system has the inherent weakness of a set-up with a dominant country-issued reserve currency, wherein the reserve issuer runs fiscal and external deficits to meet growing world demand for reserve assets and where there is no ready mechanism forcing surplus or reserve- 1.1 The international monetary system issuing countries to adjust (Mateos y Lago et al., 2009). under scrutiny The global economic crisis has put the spotlight on the Reform of the international monetary system is once international monetary system’s ability to play its key roles, again on the agenda.1 Since the onset of the current global identified as the financial crisis, the credibility of the international monetary system has come under intense scrutiny, prompting calls framework that facilitates the exchange of goods, services for reform by a number of influential policy-makers in the and capital among countries, and that sustains sound developed and developing world alike. Although this is economic growth, and [that a principal objective is] the nothing new and, indeed, such calls often come to the fore continuing development of the orderly underlying condi- at times of crisis, the integration and interconnectedness tions that are necessary for financial and economic stability of today’s world economy pose new challenges to policy- (Article IV, Section 1, IMF Articles of Agreement). makers and raise the question of whether a framework of rules is needed to ensure coordination of policies and The international monetary system is thus expected to support economic growth.2 While neither the global provide the framework that ensures adequate liquidity financial and economic crisis of 2008–09 nor the on-going without fuelling inflation and enables global imbalances to sovereign debt crisis can be characterized as be corrected, or restricts their emergence, while facilitating currency crises, they have highlighted the need for greater an orderly payments system. It is also important that it policy coordination and triggered renewed questions should inspire confidence globally, with both the costs and about the capacity of the international monetary system burdens shared equitably among those who benefit from to correct imbalances and support an orderly payments its smooth functioning. system. On several counts, however, the international monetary With an increasingly integrated world economy divided system has proved to be inadequate. It relies on the dollar into one camp of major currencies that float freely and as the predominant international currency, but the United permit the free flow of capital, and another camp with States’ ability to use exchange-rate depreciation to boost

1 In the run-up to the London G20 summit in March 2009, the Governor of the People’s Bank of China (PBoC), Zhou Xiaochuan, released a statement titled ‘Reflections on Reforming the International Monetary System’, which is considered to be one of the most influential calls for reform of the international monetary system in recent years. See Zhou (2009). For more details on the current debate on reform of the international monetary system, see Mateos y Lago et al. (2009), Sarkozy (2010), Stiglitz et al. (2010), Subacchi and Driffill (eds) (2010) and Farhi et al. (2011). To track the efforts of policy-makers, academics and other experts on reform proposals, the IMF has set up a dedicated website at http://www.imsreform.org/index.htm. 2 Subacchi and Driffill (eds) (2010). For earlier debates on international monetary reform see Aliber (1966), Triffin (1968, 1988), US Gold Commission (1982), and Krugman (1984). 1 3 Carlo A. Ciampi notes in Kenen, Pappadia and Saccomani (1994) that the term ‘non-system’ was used much earlier, perhaps in the early 1970s.

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economic growth and help correct its current-account The severity of the current financial crisis has high- deficit has become increasingly viewed by other countries lighted the urgency of addressing some of the flaws in as incompatible with its role as issuer of the primary inter- the international monetary system in order to create a national reserve currency. As confidence underpins the framework for greater financial stability in the future, and entire system, other countries look to the United States with it the restoration of long-term economic growth. The to maintain simultaneously the stability of the dollar’s focus of the debate is on the following issues: purchasing power and an inflation rate consistent with the • the perennial problem of a national currency as an preferences of the primary reserve holders. international reserve asset; In the early 1960s the Belgian-born economist Robert • the potential weakness of the US dollar as a reserve Triffin warned that the use of one national currency to asset and international currency; manage the world’s liquidity was likely to lead to a conflict • the development of large global imbalances which between short-term domestic and longer-term interna- can undermine the financial stability of the world tional objectives.4 When these conflict, national interests economy. will tend to prevail. The requirement that global liquidity should be supplied in the form of national financial assets A key question, therefore, is whether the primary reserve (usually government debt) creates further challenges; it currency needs an external anchor6 to guarantee that its has been argued that the appetite for US dollar assets, as value could be maintained. In the past, such an anchor was demand for international reserves increased in the 2000s, provided by gold, but both the Gold Standard and subse- depressed US interest rates and fuelled the borrowing quently the Bretton Woods framework, which incorporated boom. The sustained depreciation of the US dollar from gold, proved to be flawed.7 Many years later, however, the 2002 prompted a partial shift towards other reserve assets vexing issue of value has not gone away, despite the current such as the euro, but flaws in the eurozone’s governance, low rates of inflation, so this is an opportune time to rethink and the inability to compete in terms of size and liquidity this question and offer fresh thoughts and recommenda- of markets, meant that the dollar continued to dominate.5 tions on reforming the international monetary system. In the longer term, with economic growth in much of the developing world, notably China, expected to continue to outstrip the pace of expansion in the United 1.2 The return of the gold debate States itself, the capacity of the latter to support the world’s primary reserve currency is gradually being Recent developments in the world economy, notably the eroded, prompting renewed questions about the future sharp rise in the price of gold, a shift in role of the US dollar. As US hegemony appears to be behaviour with respect to bullion, and the decision by declining, the distribution of costs and benefits of some clearing houses and financial institutions to accept the current system has become controversial. This is gold as collateral have all contributed to bringing gold reflected in debates over the governance of international to the fore in discussions on reforming the international monetary institutions such as the IMF, or the responsi- monetary system. bility of those countries in surplus and deficit to adjust The role of gold often evokes strong emotions and their economies. reveals existing prejudices across the policy spectrum; on

4 Testifying before the US Congress in 1960, Triffin exposed a fundamental problem in the international monetary system – the ‘Triffin dilemma’ – which suggests that to supply the international community with adequate liquidity, the reserve currency issuing nation (the United States) has to run a current- account deficit. In doing so, it becomes more indebted to foreigners. This eventually leads to an erosion of confidence in the value of the reserve currency (US dollar) (IMF, 2012). 5 For further reading, see Cohen (2010). 6 Usage of the term anchor in this report refers to whether gold has a role in being tied to or linked with the expansion or contraction of the global 2 monetary base. 7 See details in Chapter 2.

www.chathamhouse.org Introduction

occasion it has been politically exploited. At one end of the of the World Bank, has said that a new monetary system spectrum are those politicians, such as Ron Paul, a liber- should ‘consider employing gold as an international tarian Republican presidential candidate in the United reference point of market expectations about inflation, States, who have always distrusted central government, deflation and future currency values’.14 lambasted the Federal Reserve over its loose monetary A ‘Bretton Woods III’, however, still remains a distant policies and long argued for a return to the Gold Standard goal, and it is already abundantly clear that the lack of era as a way to limit discretion.8 Many on the other side political consensus at the G20 level would make the of the debate dismiss suggestions that gold could play a creation of a new monetary architecture a prolonged useful role in the evolution of the international monetary process. Since an initial flurry of activity, the momentum system, following ’ description of the for reform within the G20 has waned noticeably, with Gold Standard as a ‘barbarous relic’.9 Even in 1923 Keynes leaders increasingly preoccupied by the urgent need to argued that ‘advocates of the ancient standard do not address the eurozone’s sovereign debt crisis. In fact, at the observe how remote it now is from the spirit and require- Cannes Summit in November 2011, many of the reform ments of the age’.10 initiatives were left off the agenda altogether.15 In the Today, the myriad problems facing the world economy absence of a broad consensus among key governments, as it struggles to recover from a deep financial crisis has change and reform of the system, if it is to come at all, prompted repeated calls by French President Nicolas is most likely to arise from a gradual process of incre- Sarkozy and other policy-makers to establish a new mental adjustment and adaptation. A ‘big bang’ approach Bretton Woods framework. ‘We live in a new world, so we to reform is clearly not on the cards as the international need new ideas,’ he announced boldly in January 2011 as he monetary system has evolved in such a way that all key set out his ambitious G20 mission.11 The aim, he stressed, members are locked by divergent interests in a form of would be to reduce exchange-rate volatility in currency stable disequilibrium (Subacchi and Driffill, 2010). and commodity markets, dampen global capital flows and In pursuing a more evolutionary approach to reform, address the world’s trade imbalances which he said were the Group of 20 leading economies, together with the being caused by ‘international monetary disorder’.12 IMF, have been looking for ways to bolster the interna- A number of influential and mainstream policy-makers tional monetary system, for example by exploring how have argued that it would be beneficial for gold, once to expand the currency basket behind the Fund’s Special again, to play a more significant role in the international Drawing Rights (SDRs) by incorporating the currencies monetary system, without advocating a return to a gold of a number of key emerging markets (IMF, 2011a; IMF standard per se. The former Italian prime minister and 2010). Since the global financial crisis, the governor former president of the European Commission, Romano of the People’s Bank of China, Zhou Xiaochuan, has Prodi, has proposed the creation of a euro bond backed by suggested that SDRs could eventually replace the US member states’ gold reserves.13 Robert Zoellick, president dollar as a global reserve currency and that the renminbi

8 Forbes, S., ‘If you want to restrain government, you restrain the power to create money. And that's what gold does.’ ‘Dr. Ron Paul's Gold Standard’, Forbes, 13 January 2010, available at http://www.forbes.com/2010/01/13/gold-standard-fed-intelligent-investing-ron-paul.html. As the US presidential campaign heated up, Herman Cain, then Republican candidate, added his voice to the gold debate, saying that he would like to return to a world where ‘a dollar is a dollar’ and that ‘yes, we do need a gold standard for that’. Tett, G., ‘Is there a shadowy plot behind gold?’, Financial Times, 22 October 2011. 9 ‘In truth, the gold standard is already a barbarous relic.’ Keynes (1924), p. 172. 10 Keynes (1923), pp. 172–3. In addition, , and other prominent public economists have dismissed a return to the gold standard. 11 Sarkozy (2011). 12 Giles, C. , 'Uphill battle for French G20 Presidency', Financial Times, 22 September 2011. 13 Romano Prodi and Alberto Quadrio Curzio, 'EuroUnionBond, here is what must be done', Il Sole 24 Ore, 23 August 2011. 14 Zoellick, R., ‘The G20 must look beyond Bretton Woods II’, Financial Times, 7 November 2010. 15 Europe’s sovereign debt crisis and in particular, then Greek Prime Minister George Papandreou’s decision to hold a referendum over a proposed bail-out 3 deal, overshadowed G20’s reform agenda at Cannes in November 2011.

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and the currencies of other developing economies should apart from other commodities such as or other now be adequately represented in the underlying basket.16 precious metals, that it could perhaps play a future role Broadening the basket, according to the Chinese in bolstering the system? authorities, could set the stage for transforming what is now little more than an accounting unit into a global reserve currency to rival the US dollar and the euro, 1.3 The Chatham House Gold Taskforce thereby facilitating world trade and bolstering the stability and the goals of the report of the .17 To date, however, little progress has been achieved on this front as the proponents To address these questions and, most of all, to assess what of an expanded SDR basket face opposition, particularly contribution, if any, bullion could make to the current from the United States, which points out that currencies international monetary system in the wake of the global such as the renminbi cannot be considered for inclusion financial crisis, Chatham House set up a global Taskforce unless they are both widely traded and freely convertible. of experts in 2011. The purpose of the Taskforce was to Indeed in October 2011 the IMF Executive Board rejected enable dialogue and discussion between independent broadening the SDR basket (IMF, 2011a; IMF, 2011b). experts, policy-makers and business leaders on critical Gold, meanwhile, has not been a central element in issues related to gold and the international monetary recent mainstream research or policy discussions on system. The Taskforce took a fresh and open-minded reforming the international monetary system, beyond the approach to exploring the advantages and disadvan- renewed calls by Zoellick and other policy-makers who tages of reintroducing gold in the system and identified believe it should be part of the solution. Indeed, the last a number of possible scenarios for reform. Building prominent policy group to discuss the role of gold was on the analysis of the Chatham House publication, the US Commission on the Role of Gold in the Domestic Beyond the Dollar: Rethinking the International Monetary and International Monetary Systems in 1982. At that System (Subacchi and Driffill (eds), 2010), the work of time, the Commission concluded that the flexibility of the Chatham House Taskforce aimed to fill a gap in the the post-Bretton Woods era was preferable to a formal renewed debate on the pros and cons of a fiat money-based role for gold, but given the lack of progress with the international monetary system versus one anchored or reform process today, there is merit in assessing in greater partially anchored by gold.18 depth whether gold could once again play a useful role in In assessing the pros and cons of using gold in the inter- addressing some of the problems facing the international national monetary system, the Taskforce was fully aware monetary system. of the cloud that bullion had left in the aftermath of the Can gold provide the system with an anchor or at least Gold Standard experience and the demise of the Bretton partial anchor that is universally trusted? Can the role of Woods arrangement. But the Taskforce was also suffi- gold be expanded or formalized as an indicator to gauge ciently intrigued by some of gold’s positive characteristics inflation expectations or as an early signal of changes in and the growing interest it has attracted since the onset of US interest rates – beyond the role it performs currently the financial crisis to warrant a fresh look at bullion in the as a hedge or safe haven? What is so special about gold context of reforming the system. that, despite its demise as a long-standing anchor in This topic is not new to Chatham House. Indeed between the international monetary system nearly 40 years ago, 1929 and 1931, Chatham House convened a special Study some influential policy-makers believe it could once Group on ‘The international functions of gold’ to examine again play a useful role in this regard? What sets gold the problems arising from the post-war international

16 Chinadaily.com, 23 March 2009. See also Kenen (2010). 4 17 See Wiesmann, G., ‘IMF urged to ease way for renminbi’, Financial Times, 2 September 2011. 18 Fiat money/currency is money whose value depends on the power and standing of the issuer, usually a sovereign with the power to tax.

www.chathamhouse.org Introduction

monetary settlement, which contributed to the Great price stability and gold, he argued it was important to Depression and ultimately led to the suspension of the distinguish between two different issues: ‘Has the handling Gold Standard by the British government in September of the credit question been prejudiced by gold shortage or 1931. This Study Group,19 which included John Maynard gold maldistribution?’ and ‘has the credit question been Keynes, was of course grappling with a very different mishandled despite adequate gold?’ (Kisch, 1931). Kisch set of issues from those facing today’s Chatham House noted that the amount of gold actually held by central Taskforce, but delving into its findings is instructive for banks relative to the total deposits in money was compara- drawing out what lessons, if any, are relevant in deter- tively small, but that on these small proportions of bullion mining whether gold could once again have a useful role an enormous credit structure was raised. to play in bolstering the international monetary system It was important, therefore, that all countries had the some 80 years later. same views concerning the amount of gold required to After three years of severe economic crisis, by 1931 the maintain the credit structure. However, the gold problem, UK economy had become hamstrung by the Gold Standard, Kisch pointed out, was viewed very differently in different which made it impossible for the sterling countries. The United States and , which had the to shoulder the burden of adjustment. This forced the largest gold reserves, were ‘not predisposed to regard gold embattled British government to break the pound’s fixed as a serious culprit in the matter of world depression’, parity with gold and to devalue the currency. The result whereas the , whose gold holdings by was a rapid improvement in the competitiveness of British comparison were relatively small, held the view that ‘gold exports; cheaper credit was made available and the UK has played a large part in precipitating the catastrophic economy began to emerge from depression (Schenk, 2011b). price fall in recent years’ (Kisch, 1931). Prior to the UK’s decision to abandon the Gold In Keynes’ view, the most pressing issue was to sustain Standard, two of the key concerns preoccupying members international lending to prevent a global liquidity crisis, of the Study Group were that gold could not be mined and he looked to France and the United States, with large fast enough to match the growth of the global economy, gold holdings, to lend more – not entirely different from and the fact that the United States and France held the today’s situation of global imbalances and the massive lion’s share of gold in the world. This prompted the Study accumulation of foreign-exchange reserves by a number Group to focus on proposals aimed at addressing ways of of central banks. The analogy stops there, however, given ‘economizing’ on gold, which would enable central banks that this was a period of plummeting prices, and an era to operate a Gold Standard with far less bullion than had when the gold price had been very stable for a long time. previously been required.20 In fact, in the previous 100 years to 1930, the price of gold In attempting to answer the question: ‘how far is gold had only risen marginally from $19/oz to $21/oz (Schenk, a player in the tragedy of the price collapse?’, the Study 2011b). These features of the international monetary Group’s deliberations were not conclusive, but as one system back then stand in stark contrast to the volatile gold member, Sir Cecil Kisch, put it, ‘it is easy to make it the prices of recent years (see discussion in Chapter 4, and scapegoat’. In setting out the Study Group’s thinking on particularly Figure 4.1).

19 The papers delivered before the Study Group from 1929 to 1931 are published on the Chatham House website. See Royal Institute of International Affairs Study Group (1931), available at http://www.chathamhouse.org/publications/papers/view/178235. 5 20 See also the Genoa Conference of 1922.

www.chathamhouse.org technological advances and international migration, the deflation prevalent up to the mid-1890s was not accompa- nied by dramatic falls in output.22 To finance the war effort, however, the Gold Standard was suspended by combatant countries during the First 2. From the Collapse World War as governments issued inconvertible paper currency and prices rose sharply with the increase in of the Gold Standard demand for military supplies. Once the war came to an end, there was a widespread desire to restore the Gold to the Demise of Standard, but monetary expansion during the conflict had pushed prices up so much that when calculated at pre-war Bretton Woods parities the available supply of gold had declined relative to the money value of the income it was intended to support. What emerged was a Gold Standard (or Gold Exchange Standard) in which most countries were encouraged to hold mainly foreign currencies, notably sterling or the US dollar, as their international reserve assets, rather than 2.1 Why did the Gold Standard fail? gold. Gold was withdrawn from public circulation in most countries and replaced with paper notes and non-gold In modern times, the international monetary system has coins, with their convertibility restricted to wholesale been subject to the discipline of a gold standard on two amounts. occasions: the Gold Standard of 1870–1914, and the Gold Because inflation levels during the First World War had Exchange Standard of the inter-war years, both of which varied greatly between nations, some of the countries that have been associated with periods of sharp and painful returned to the Gold Standard chose to enter at pre-war economic depressions (the 1890s and the 1930s).21 In prices while others adopted new valuations. The United the run-up to the First World War, the Gold Standard Kingdom, for example, returned to the Gold Standard provided the foundation for the expansion of the global in 1925 at pre-war parity despite a dramatic reduction in economy in the first age of globalization. This was a time its international competitiveness. Others, such as France when governments had a limited responsibility for the and , did so at a new parity that devalued their economic welfare of their populations and intervened less national currencies from pre-war levels, in effect making in their national economies. Monetary policy sovereignty the wartime inflation of prices permanent. was not deemed to be as important as today, so the loss Meanwhile, , which had left the Gold Standard of sovereignty required for the Gold Standard was more in 1914, was in no position to re-enter after the war as it had easily forgone. Indeed, adherence to the Gold Standard been forced to sacrifice much of its remaining gold reserves was sometimes interpreted as a ‘seal of approval’ to inter- in reparations. As a result, the German authorities issued national markets of the creditworthiness of emerging virtually limitless amounts of marks without any backing markets (Bordo and Rockoff, 1996). The 19th-century to buy foreign currency to restore economic growth and Gold Standard was also supported by the use of sterling pay for further reparations. This led to the unprecedented as an international currency that greased the wheels of the early 1920s in the Weimar Republic. of commerce. In a period of globalization driven by Under the Gold Standard, hyperinflation would have been

21 The Bretton Woods era is sometimes equally described as a Gold Exchange Standard in the light of the US dollar’s gold convertibility. 6 22 It should be noted that the physical volume of gold had not declined, and the problem probably could have been resolved had the price of gold been increased by a factor of three or four.

www.chathamhouse.org From the Collapse of the Gold Standard to the Demise of Bretton Woods

impossible as the money supply could only expand at the before the United States, having suffered from further rate at which the gold supply increased but, without the deflationary effects, was finally forced to abandon the Gold backing of bullion, Germany lost its anchor for long-term Standard, and only at this point was the country finally price stability. able to embark on a sustained economic recovery. The Gold Standard of the inter-war years did not last long, collapsing in stages between 1931 when the United Kingdom left it and 1936 when its last adherents, France, 2.2 The rise and fall of Bretton Woods the and , abandoned it. The final straw for the United Kingdom was its realization in In the early 1940s British and American policy-makers mid-1931 that the low ratio between its gold holdings and (notably John Maynard Keynes and Harry Dexter White) the amount of short-term obligations that could poten- began to draw up plans for a post-war international tially draw on these reserves made it impossible to defend monetary system. This culminated in the Bretton Woods the fixed value of gold (Schenk, 2011b). Conference of 1944 at which 44 countries endorsed a plan Despite the adjustments and modifications that had to set out a clear set of rules, institutions and procedures to been made to the inner workings of the Gold Standard govern the international monetary system in the aftermath in the pre-war years, the fact that the new financial of the Second World War. framework required price deflation as a precondition for The Bretton Woods arrangement was backed by the economic growth and prosperity proved to be a fatal flaw. creation of two new institutions, the IMF and the World Indeed, the requisite price deflation would have had to Bank, which were established to help build a framework be accompanied by even higher levels of unemployment for economic cooperation designed to avoid a repetition of and further large falls in living standards, which would the vicious cycle of competitive devaluations of the 1930s. have been politically unpalatable in Britain and elsewhere. Indeed, policy-makers learned one of the key lessons of the Eventually this forced all the other countries, one by one, inter-war years: they set as a major objective of the Bretton to abandon the Gold Standard. Woods agreement the establishment of a new monetary Whether the Gold Standard was responsible for system capable of preventing the ‘beggar-your-neighbour’ prolonging the Great Depression or merely contributed to policies that had contributed to the breakdown of the it is a matter of some debate, but it clearly prevented the Gold Standard and had prolonged the Great Depression banking crisis of 1931 from being contained (Eichengreen, (Subacchi and Jenkins, 2011). 1992). Indeed it limited the ability of central banks to rely The new political and economic dispensation reflected on monetary policy to combat falling prices by expanding the hegemony of the United States as the dominant power the money supply and lowering interest rates. In the of the post-war period and with it the consolidation of United States the Federal Reserve, whose commitment the US dollar’s supremacy as the world’s pre-eminent and adherence to the Gold Standard was underlined by currency (Eichengreen and Flandreau, 2009). Under the its reluctance to engage in expansionary monetary policy, Bretton Woods agreement, gold was still important but defended the fixed price of dollars with respect to gold it had a less prominent role to play. Countries agreed until 1933. In an environment of plummeting demand to a system of fixed but adjustable exchange rates where and economic contraction, the Federal Reserve actually most international currencies were pegged directly or raised interest rates in 1931 at a time when the economy indirectly to the dollar, which in turn was tied to gold was in near freefall and maintained high rates in a bid to at a set price of $35/oz.23 Central banks had the right to increase demand for US dollars. It took a further two years convert their dollar holdings into bullion, and the London

23 Pegging to the US dollar was de facto. Formally, according to Article IV of the original Articles of Agreement, parities were to be defined in terms of gold or in terms of the US dollar ‘of weight and fineness of July 1, 1944’, i.e. gold. So gold was intended to remain the ultimate unit of account for exchange 7 rates. Countries in the Commonwealth mainly pegged to sterling, which was itself pegged to the dollar (Schenk, 2010).

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gold market was re-opened in 1954 but still sanctioned by served as a secondary global reserve asset, speculation exchange controls. In effect, all currencies pegged to the against the US dollar price of gold ratcheted up, causing US dollar implicitly also had a fixed value in terms of gold, the Gold Pool’s operations to be suspended in March 1968 enabling the greenback to establish itself as the primary (Schenk, 2010). international reserve currency. With ambitious national This was the first official step in the Bretton Woods recovery programmes, states opted to retain monetary era towards explicitly moving the international monetary policy sovereignty with limited exchange-rate flexibility system away from gold and deliberately encouraging by restraining capital flows through elaborate controls the demonetization of bullion. While central banks had (Schenk, 2010). pledged to continue trading gold at the official price of The Bretton Woods framework introduced a degree $35/oz, the private market price was allowed to float. The of flexibility in the new exchange-rate regime, allowing emergence of a parallel private market for gold where the countries facing serious economic difficulties to devalue price soared well above the official fixed price led to specu- their currencies against the US dollar in a limited way if lation and eventually prompted even central banks to cash a ‘fundamental disequilibrium’ occurred in the balance of in their dollars for US bullion. payments. They also had access to short-term funds from These pressures meant that maintaining a fixed price of the IMF to enable them to avoid undergoing the adverse gold on demand for all those holding US dollars became effects of the deflation that had characterized much of untenable. Finally, in August 1971, President Richard the Gold Standard era. Strict capital controls protected Nixon decided to suspend the gold convertibility of the the exchange-rate pegs and shielded countries from the dollar, in effect closing the gold window and triggering a damaging effects of capital flight. devaluation of the US dollar. The commitment to pegged Although the new framework underpinned a remark- exchange rates prompted a last effort to prop up the system able post-war boom in the 1950s and 1960s, the central through the Smithsonian Agreement with new parities in role of the US dollar pegged to gold increasingly created December 1971, but the market pushed the limits of the tensions within the international monetary system. As the ability to defend these new rates. From June 1972 sterling United States began running up persistently large external floated against the US dollar and from March 1973 most deficits while supplying the global liquidity required for other currencies did so too. The Bretton Woods regime international transactions, the volume of dollars held as had come to an end. It took another five years before foreign-exchange reserves by both official and private the formal role of gold was removed by an amendment holders came to exceed the amount of gold in the Federal to the IMF Articles of Agreement, which sought to Reserve by a significant amount. This gradually under- promote the SDR as the foundation of the international mined the credibility of a fixed price for gold on demand monetary system. This marked the culmination of more for all holders of US dollars. than 40 years in which the role of gold had been reduced In an attempt to sustain the credibility of an official, in progressive stages. fixed price for gold, the G10 states24 agreed in 1960 to set up a Gold Pool that intervened in the London market. But by 1966 the central banks of the G10 countries were forced 2.3 After Bretton Woods to become active sellers of gold in order to prevent its price from rising. This resulted in a significant reduction in the Although the virtue of relying on gold in the international amount of bullion held as reserve assets. Following the monetary system had been the discipline it imposed on November 1967 devaluation of sterling, which then still macroeconomic policy, this discipline also turned out to

8 24 The G10 countries were Belgium, , France, Germany, , , the Netherlands, , the United Kingdom and the United States. In 1964, the group was strengthened by the association of Switzerland, but it remained known as the G10.

www.chathamhouse.org From the Collapse of the Gold Standard to the Demise of Bretton Woods

be its Achilles’ heel. It was too rigid and the limited flexi- of payments prevented further reform. Nevertheless, bility of nominal exchange rates allowed by Bretton Woods enhancing the role of the SDR was built into the 1978 was too costly – and was only possible at all because of Second Amendment to the IMF Articles of Agreement, the existence of widespread capital controls during that which spelt out the members’ commitment to bolster the period (Driffill, 2010). When the effectiveness of capital role of SDRs as the primary international reserve asset, controls was eroded with the rise of offshore markets independent from gold. The demonetization of gold was through the 1960s, states could no longer pursue monetary thus achieved, but the initiative to enhance the role of policy sovereignty at pegged exchange rates. Rather than SDRs was never fulfilled (Schenk, 2011a). Largely because abandon sovereignty, states allowed exchange rates to float. of the enormous and liquid market for US dollar assets, The evident weaknesses of the the post-Bretton Woods system continued to function prompted initiatives to reform the international monetary reasonably well, although not without problems, in the system, and more specifically proposals to develop a delib- decades that followed.25 erately managed and neutral global reserve asset, culmi- The experience of the prolonged collapse of the Bretton nating in the development of the IMF’s SDRs. Initially Woods system showed the difficulty of retaining pegged agreed in 1967 and implemented by the Fund in 1969 as exchange rates in an environment of increasing capital part of the Bretton Woods system, they never developed mobility when nation-states prioritize the exercise of as hoped. Proposals to enhance the role of SDRs and to independent monetary policies. The gold anchor proved reduce the role of national currencies were put forward unsustainable as the market lost confidence in the ability in 1972, but the technical limitations of the SDR, uncer- of G10 central banks to defend the fixed gold price of tainty about the implications for international liquidity the dollar. In considering this issue for the future much and disagreements over whether such proposals would depends, therefore, on the long-term credibility of main- relax pressure on the United States to correct its balance taining any gold anchor.

25 See, for example, the Plaza Accord of 22 September 1985, signed by Germany, France, Japan, the United Kingdom and the United States to depreciate 9 the US dollar in relation to the Deutschmark and the yen by intervening in currency markets.

www.chathamhouse.org surplus. By taking advantage of its cheap labour costs, China was able to export lower prices to the rest of the world and then funded the United States’ ever-growing current-account deficit by investing its own surplus into US Treasury bonds. 3. Current Challenges Today, as the United States and West European countries struggle to extricate themselves from the worst financial for the International crisis since the Great Depression, the contrast with devel- oping Asia is striking. Economic growth continues to Monetary System disappoint in the United States, weighed down by a housing market which remains in the doldrums. In the eurozone the sovereign debt crisis has sparked serious concerns that the world economy may tip back into recession. And, in the aftermath of far-reaching government and central bank interventions to bail out numerous banks and other 3.1 The world economy in transition financial institutions, the developed world is now faced with a mountain of public debt that is partly the consequence In the past 20 years, the world economy has undergone a of the bail-out of troubled banks and/or fiscal stimulus radical transformation, which has contributed to increased packages aimed at kick-starting national economies. vulnerabilities in the international monetary system. The By contrast, GDP growth in developing Asia, led by China, dividend from the end of the with the has continued to far outstrip economic expansion in the West. subsequent break-up of the former Soviet Union, together Indeed the contribution of developing Asia to world output with the rapid rise of China and on the world stage, growth has doubled in the past 20 years, and now represents have placed new demands on the system. Tensions were more than a quarter of global GDP (Asian Development less evident while the world economy was booming in the Bank, 2011). In the wake of three decades of economic first decade of the 21st century, but with the onset of the liberalization, China has already overtaken Germany as crisis, the fragility of the international monetary system the world’s largest exporter, and has now leapfrogged the has come to the fore.26 United States to become the world’s biggest market for cars. The global banking crisis, following a period of un- China could well surpass the United States as the largest precedented leveraging in the financial system, occurred economy in the world within the next decade. At current in the first instance because of excessive risk-taking by market prices, the United States’ GDP of $14.5trn in 2010 many banks, especially in the sub-prime sector of the is still far ahead of China’s $5.9trn, but calculated on the United States housing market, and because of bad risk basis of purchasing power parity (PPP), which measures management. These distortions were facilitated on the one GDP using exchange rates adjusted for price differences hand by global imbalances driven by Americans who were of the same goods between countries, China’s economy encouraged to live beyond their means and who leveraged is already close to that of the United States and could cheap credit, and on the other by Chinese exporters and overtake it within several years.27 Still, on a per capita basis, savers who were generating an enormous current-account China remains a relatively poor country and it faces some

26 Nonetheless, the crisis has also revealed some of the strengths of the international monetary system in containing its adverse effects and actually reducing global imbalances (Allen and Moessner, 2011). The Asian financial crisis of 1997–98 was the first signal that the international monetary system was unstable. The response to that crisis, namely managed exchange rates and persistent imbalances, has shifted the crisis from the international monetary system to the international financial system. For more details on the distinction between the two, and the use and function of an anchor, which is different 10 in each system, see Fosler (2011b). 27 See ‘Climbing Greenback Mountain’, Special Report: The World Economy, The Economist, 24 September 2011.

www.chathamhouse.org Current Challenges for the International Monetary System

severe challenges, such as fragility in the banking and However, these benefits have increasingly been a financial system, as well as growing income inequality, that mixed blessing, particularly since the onset of the current threaten its path to prosperity. financial crisis. This state of affairs has produced a poten- tially destabilizing situation, with the United States, the world’s largest economy, becoming by far and away the 3.2 The buck stops here? largest debtor, and China, the world’s largest creditor, assuming an enormous currency mismatch risk in the Being the issuer of the world’s principal reserve currency process of financing American debt. has no doubt benefited the United States in a number The enormous quantity of outstanding US dollar assets of ways – what the then French finance minister Valéry held by central banks, the long-term weakness of the US Giscard d’Estaing ruefully described in the 1960s as dollar since 2002 (Figure 3.1) and doubts about the worth ‘exorbitant privilege’. The United States has had far of such a mountain of American debt have all contrib- more control over its own monetary policy than would uted to a renewed interest in replacing the dollar as the otherwise be the case, and it has enjoyed lower financing primary reserve currency. At present, however, there is no costs than other developed countries. Moreover, it does genuine or credible alternative. To host an international not need to acquire costly reserves of its own and worry currency requires deep and liquid financial markets, and about the risk of an external financing crisis if its exports the US Treasury and bond market continues to be unri- become uncompetitive, given that it can always print more valled. Among the other currencies used as international dollars.28 As the World Bank summed it up, countries like reserves, neither the euro nor the yen currently has the the United States ‘benefit from domestic macroeconomic potential to become the primary reserve currency. Even policy autonomy, seigniorage revenues, relatively low before the sovereign debt crisis afflicting the eurozone, borrowing costs, a competitive edge in financial markets there were question marks over the willingness of the and little pressure to adjust their external accounts’.29 European authorities to allow the euro to become a key

Figure 3.1: US dollar effective exchange rate

140 Real Nominal 130

120

110

100 Index 2010 = 100 Index

90

80

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Source: Effective Exchange Rate Indices, Bank for International Settlements.

28 Ibid. 29 See ‘Global Development Horizons 2011 – Multipolarity: the New Global Economy’, World Bank, 2011, in Saft J., ‘Welcoming the dollar’s demotion’, 11 International Herald Tribune, 20 May 2011.

www.chathamhouse.org Gold and the International Monetary System

reserve currency. Meanwhile, the yen cannot be a serious emerging markets are recognized, changing from a dollar- contender as the Japanese economy remains too small denominated system to a multi-currency one’.30 to support a reserve currency and, like the eurozone, its This is in line with the findings of a UBS survey in May growth is too slow and it is predominantly in surplus 2011 of more than 80 central bank reserve managers, (Nugée, 2010; Cohen, 2011). sovereign wealth funds and multilateral institutions, Although the US dollar’s position has been weakening collectively controlling over $8trn in assets. More than half and there has been some diversification of global reserves of the managers polled at UBS’s annual seminar predicted (albeit inflated by exchange-rate changes), it is still unques- that the US dollar would be replaced by a portfolio of tionably the world’s principal reserve currency and it currencies within the next 25 years.31 This marked a continues to serve as a safe haven because of its liquidity. distinct shift from previous surveys, in which the majority The diversification of reserves, which reflects concerns of managers believed the dollar would retain its status as about the US dollar as a , nonetheless obscures the principal reserve currency. The results underscored the fact that it continues to dominate markedly in its other the growing dissatisfaction with the dollar amid moves to functions as the world’s primary international currency: diversify away from it. They also pointed to an increased as a medium of exchange and as a unit of account. And role for bullion over the next decade, with 6% of managers even despite anxieties about its role as a store of value, 85% saying the biggest change in their reserves would be to add of all foreign-exchange transactions are still made in US more gold – in contrast to previous years when none of the dollars; half of all foreign debt securities are denominated managers polled said they intended to do so. in dollars; two-thirds of US banknotes circulate abroad; and much of continues to be invoiced in dollars (Glick, 2011). Down the road, however, as the 3.3 The rise of the renminbi US share of world GDP continues to decline, the sustaina- bility of the dollar’s dominant position in the international In the light of the growing dissatisfaction with the US monetary system, not just as a store of value but also as a dollar as the world’s primary reserve currency, and given medium of exchange and a unit of account, is likely to be that neither of the other contenders for the top spot – the brought into doubt, making its foundations increasingly euro and the yen – is in a position to become the dominant unstable. player in the international monetary system, many more According to the World Bank, the growing impor- eyes are turning towards the renminbi as a possible tance of emerging markets over the coming decade – answer, but this shift is expected to be a gradual process. particularly China, which will account for an ever larger Although the US dollar may be suffering from long-term share of the global economy – is expected to lead to a weakness, there is still no other currency that can compete multi-polar world where the US dollar will lose its status with it today. The renminbi still has very little interna- as the primary reserve currency by 2025 and share the tional exposure, is not fully convertible, and operates in top spot with the euro and the renminbi. The World Bank a country lacking a sound institutional framework – all believes this scenario for the international monetary major handicaps. system is more likely than a status quo scenario centred Moves to internationalize the currency will also provide on the US dollar, or one using SDRs as the main interna- the government with an opportunity to move away from tional currency (World Bank, 2011). As the former head its long-standing but controversial growth strategy.32 As of the IMF, Michel Camdessus, said recently, the interna- World Bank president Robert Zoellick has pointed out, if tional monetary system will need to be ‘renewed so that the Chinese authorities hope to continue expanding the

30 See ‘Emerging markets to account for 80% of future global growth: ex-IMF chief’, Xinhua News Agency, 24 June 2011. 12 31 See Farchy, J., ‘Central banks see shift from dollar’, Financial Times, 28 June 2011. 32 See Subramanian A., ‘Coming soon: when the renminbi rules the world’, Financial Times, 12 September 2011.

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economy at the pace of the past three decades, it is hard renminbi inflows back to onshore asset markets, it repre- to see how that expansion could be accommodated within sents another important step in completing the circle for an export and investment-led growth model, so China will the global circulation of the currency (HSBC, 2011). need to rebalance through boosting demand, lowering Another small step in the gradual internationalization of savings and increasing consumption. Without far-reaching the renminbi came with the announcement by the Hong structural changes, China risks becoming caught in a Kong-based Chinese Gold and Silver Exchange Society on ‘middle-income trap’.33 And to escape it, China will have to 17 October 2011 that it was launching a new service that abandon many of the current restrictions on the renminbi. allows institutional and retail investors to use their renminbi These big policy challenges are being pursued as part bank deposits to buy gold for the first time. The product, the of a two-pronged strategy, first by boosting cross-border Renminbi Kilobar Gold, enables investors to settle either usage of the renminbi in trade settlements and secondly through a spot market (to buy the goods and allow for settle- by making the local currency more attractive to non- ments in two days) or physical delivery (moving the goods residents by developing an offshore market in Hong Kong and cash to a place for exchange). While it is a spot contract, for renminbi-denominated assets (Subacchi, 2010). As a the physical delivery can be deferred if both the buyer and result, the value of cross-border trade transactions denom- seller agree. The Hong Kong renminbi gold market thus inated in renminbi has surged from virtually nothing in serves two main purposes: it allows Chinese investors to 2009 to more than $265bn in the first 10 months of 2011.34 buy gold with renminbi and it also gives offshore renminbi In a further sign that this strategy is being pursued real purchasing power. Although this innovation is unlikely vigorously, both and London have been singled to have immediate repercussions beyond Hong Kong, it out as future trading centres for the renminbi. Although, is an important part of the territory’s strategy to establish for political reasons, Singapore is unlikely to overtake itself as China’s offshore financial services centre, and it Hong Kong as the primary offshore trading hub for the also signals Beijing’s methodical approach to raising the renminbi, it has the financial infrastructure to become international profile of the renminbi.35 another key trading centre for the Chinese currency. However, it will still be quite a leap for the renminbi to Meanwhile, making London an alternative hub should transform itself from being a currency in which a certain provide additional impetus to China’s internationalization amount of the country’s trade is settled to being a fully- strategy by giving Beijing access to the largest foreign- fledged international currency – let alone one enjoying exchange trading centre in the world. reserve-currency status. Only a tiny fraction of the world’s Underscoring Beijing’s desire to bolster the offshore $4trn in foreign-exchange deals each day is for trade settle- renminbi market, China announced that effective 13 October ment. The US dollar, meanwhile, continues to dominate all 2011 foreign companies holding renminbi deposits outside currency trades (85%), with the renminbi still accounting the country would in future be able to use them for foreign for a minuscule 0.3% of turnover.36 direct investment (FDI) into China. Representing an Nonetheless, the strategy to internationalize the currency important new step in the Chinese authorities’ attempts to will be given an additional boost if the renminbi is ease the country’s financial controls, this development will included in SDRs.37 In 2009 China’s central bank governor provide a further boost to the so-called dim-sum bond called for the creation of ‘an international reserve currency market (renminbi-denominated debt issued offshore) as that is disconnected from individual nations’, arguing that a potential channel for FDI funding, particularly in Hong reform ‘should be a gradual process that yields win-win Kong. But just as significantly, by opening a channel of results for all’ (Zhou, 2009).

33 See Zoellick R., ‘The big questions China still has to answer’, Financial Times, 2 September 2011. 34 The data are from Ministry of Commerce, China (November 2011). 35 McKelgue J., ‘A new way to buy gold with “redbacks”’, MoneyWeek, 18 October 2011. 36 ‘Climbing Greenback Mountain’. 13 37 Some observers expect the renminbi will already be included in the SDR basket by 2015. See Saidi et al. (2011).

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The G20 under President Sarkozy pursued this goal place. Adding to the challenge is the fact that China is the by pressing for the renminbi’s inclusion in the currency first country that will be attempting to internationalize its basket if China was willing to make concessions on its currency in the era of fiat money where there is not even exchange-rate regime. However, this initiative met with a residual link between the reserve currency and gold. As opposition, especially from the United States, which re- a result, the renminbi will be forced to compete directly iterated that to be included in SDRs, currencies have to be with the US dollar in the international arena, as opposed to widely traded and freely convertible.38 establishing its credibility by comparing the convertibility In any event, the renminbi’s course to full internation- of both currencies to gold. Building an international repu- alization and convertibility is unlikely to be plain sailing, tation for the renminbi, particularly when it is not fully and China will have to undertake major policy reforms on convertible, means that making it widely accepted in those several fronts to achieve its objectives, notably the devel- parts of the world where the US dollar dominates is likely opment of an institutional framework (legal, financial, to take many years (Subacchi, 2010). accounting, etc.) that other countries have taken years Thus the dollar may be suffering from long-term to establish. Although it has begun the process of inter- weakness, but its role as an international currency is nationalizing the renminbi, and perhaps even turning it certainly far from over, while the prospects for another into one of the world’s key international currencies, the global currency to replace it in the near future are challenges facing China’s policy-makers are unprece­ not bright. This could leave the door ajar for gold to dented in this regard.39 play a more deliberately managed role supplementing In theory, to achieve full convertibility China would the US dollar in the international monetary system – typically need to remove the capital-account restrictions prompting the Taskforce to consider just how this might and the domestic financial controls that are currently in be achieved.

14 38 See Wiesmann, ‘IMF urged to ease way for renminbi’. 39 For a provocative view of the rise of China in the longer term and its impact on the international monetary system see Subramanian (2011).

www.chathamhouse.org currencies. In addition to its physical characteristics enabling it to act as a medium of exchange, a store of value and a hedge against inflation of fiat currencies, its long-time historical role in the international monetary system during much of the 20th century has made gold 4. Is There a Role an attractive choice of asset for a number of central banks and other financial institutions in times of monetary for Gold? turmoil. Gold becomes more attractive when the viability of the fiat money system comes into question, when inflation expectations are high or when exchange rates among the primary global currencies are particularly volatile. Today, all three of these preconditions are evident to a greater 4.1 Benefits and costs of gold in the or lesser degree (although inflation expectations are still international monetary system relatively low), and have helped drive up the price of gold to record levels (Schenk, 2011a). While the nominal To serve as a currency, a commodity must meet several price today is very high, the gold price has soared during requirements: its physical characteristics have to be easy episodes of uncertainty in the past, particularly in the to define and it should be relatively immutable, but not to period 1979–82. In this case the price subsequently fell the extent that it cannot be purified in such a manner that sharply. The current market dynamic is compared with it is acceptable as an asset. It also needs to be relatively this previous episode in Figure 4.1, which shows that the rare. In this narrow sense, gold meets these criteria. Gold current price rise is not yet as dramatic as the surge and has the advantage that it is not degradable and also has collapse of 1979–82. Should market uncertainty recede, it the distinct benefit of not being any particular country’s is likely that the gold price will cease to climb so aggres- liability, thereby removing the risk of default versus fiat sively and it may even be reversed.

Figure 4.1: Monthly gold prices: Index Jan 1976 = 100, Index Jan 2005 = 100

600 January 2005 – October 2011 January 1976 – October 1982 500

400 October 2011

October 1982 300

Gold prices (index) 200

100

0 12345 Years

Sources: IMF International Financial Statistics and Chatham House calculations. 15

www.chathamhouse.org Gold and the International Monetary System

One key argument for reintroducing gold in the A return to a Gold Standard, with its potentially international monetary system is that there is no default deflationary bias, is widely thought to be unachievable, risk associated with bullion since it is not a liability of any not least because the supporting conditions that existed particular government. This tends to insulate gold from during its heyday are not present today – a dominant vulnerability to any single country’s economic policy, economic philosophy favouring very limited government which is particularly relevant today when government intervention, widespread restrictions on private capital liabilities are ballooning (Saidi and Scacciavillani, 2010). movements, and a belief that floating exchange rates Furthermore, it helps to reduce the impact of the Triffin undermine international trade and domestic prosperity dilemma as reserves can be built up without forcing debt (Truman, 2010).40 The power of central banks to set or issuance on another country. manipulate the world gold price has also been eroded as A second argument is that fixing the gold price of the private gold market has grown relative to the amount currency will exert discipline over the creation of money. of gold at the disposal of central banks. By helping to promote price stability, gold discipline Even a partial return to the Bretton Woods era is normally is able to keep inflation under control (so long generally deemed to be unrealistic, or undesirable, in as there are no sudden increases of supply) and also tends today’s world as the United States and any other reserve to inhibit reckless banking by restricting money supply currency country would be likely to resist the idea of growth. Unlike fixing an exchange rate to another national submitting to the discipline of a fixed value of gold. currency, the growth of the money supply is constrained Nonetheless, it is important to understand the increasingly by the growth of gold supplies rather than determined by informal role gold is once again playing in the current the economic policies of the country issuing the numeraire crisis as a hedge or safe haven. currency. Indeed, perhaps one of the great virtues of the To play an even more formal role as a hedge or safe Gold Standard era (except for the period 1896–1914 when haven it would be imperative that gold did not impose inflation emerged) was the long-term anti-inflationary unacceptable constraints on national economic policies. For impact that it provided, as the money supply could only example, it is difficult to know whether the international grow at the rate at which the gold supply increased. On monetary system would have performed better or worse in the other hand, as discussed earlier, the discipline that the present crisis if gold had been given a more formal role. the Gold Standard imposed greatly undermined the flex- Greater discipline on financial markets might have been ibility required to react to crises – a major constraint – and helpful in inhibiting the reckless banking and excessive debt the rigidity of the system forced countries down a very accumulation of the past decade. However, with the onset of damaging deflationary path in the interwar period. the global crisis, had gold had a more formal role to play, the With these issues in mind, the Taskforce considered four rigidity it imposes might also have been a handicap when a frameworks for reintroducing an element of gold to improve more flexible policy response was required. the performance of the international monetary system. It assessed the role gold could play as an anchor; as a hedge or safe haven; as collateral or guarantee; and as a policy 4.2 Gold as an anchor indicator. In addition, the Taskforce explored the possibility of including gold in an expanded SDR basket to determine Part of the appeal of gold is the notion that it could serve whether SDRs could be transformed into an alternative once again as an anchor for the international monetary global reserve currency, and it also examined to what extent system. Undoubtedly, there are some clear advantages in digital gold could play a future role in an ever-evolving inter- fixing the gold base to the amount of money in circulation. national monetary system (see case studies below). For example, as a fixed monetary anchor, gold can help

16 40 For a detailed discussion on the Gold Standard see Bernanke and James (1991), Eichengreen (1992) and Bernanke (1995). The Gold Standard could also be inflationary if substantial new gold sources were to be discovered, as was the case, for example, following the gold discoveries of 1896.

www.chathamhouse.org Is There a Role for Gold?

stem inflationary pressures, given that central banks are Adding to the challenge of using gold to anchor the inter- then unable to create unlimited quantities of paper money national monetary system is the fact that gold is traded so at will because of the limited supplies of gold. extensively in the global financial markets. Indeed, a recent Nonetheless, the adverse effects of using gold as an survey conducted by the London Bullion Market Association anchor far outweigh the benefits. Indeed, the Taskforce estimated daily trading volume at around $240bn.41 This, concluded that the prospect of gold making a comeback as coupled with the reality that the majority of gold is used an anchor to the international monetary system would be in a fabricated form for , would make it extremely not only impractical but also highly damaging. Gold prices difficult for central banks to control its price. In effect, recog- are volatile and no one, not even a central bank, is able to nizing this fact is what led the Nixon administration to end control them effectively. Although the demand for gold the convertibility of gold through the Federal Reserve at the usually increases in periods of inflationary expectations official fixed price in August 1971. Being unable to control or of economic uncertainty, it can also rise in response the gold price in private markets, central banks cannot to speculation, so managing these dynamics to guarantee ensure a fixed price relationship between gold and a given a fixed price of gold in a given currency such as the US currency. With only 34% of global gold stock held by central dollar is almost impossible (Schenk, 2011a). Moreover, banks, and in the light of the unequal distribution of these as gold prices, like those of other commodities, are often gold reserves, no single central bank is in a position to defend volatile, they are not necessarily a good counterweight a fixed price for gold in terms of domestic currency. against inflation (Figure 4.2). In fact, a serious drawback Although it is far from clear what is the ‘right’ price for is that a gold anchor can become particularly unstable gold, given the large volume of global money in circula- precisely when a stabilizing force is needed most. As gold tion, the disadvantages of using bullion as a monetary prices tend to rise when inflationary expectations and/or anchor are clear: a return to a gold standard could inflate other risks in the fiat monetary system increase, the gap the price of gold significantly, while restrictions on money between the reference price and the market price is likely supply growth could provoke a severe downturn in the to widen at times of uncertainty (Fosler, 2011a). growth cycle of global economies (Goodburn, 2011).

Figure 4.2: Commodity prices (USD): Gold (LHS), silver (RHS) and crude oil (RHS)

2,000 Gold 160

1,800 Crude oil Silver 140 1,600 120 1,400

100 US Dollars 1,200

1,000 80 US Dollars 800 60 600 40 400 20 200

0 0

1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Source: IMF International Financial Statistics.

17 41 http://www.lbma.org.uk/assets/Loco_London_Liquidity_Surveyrv.pdf.

www.chathamhouse.org Gold and the International Monetary System

Box 4.1: Are gold-laced SDRs the answer?

In assessing what role gold could play in reforming the international monetary system, the Taskforce turned its attention to SDRs in an attempt to build on the vast array of literature in recent years, including the analysis published in the March 2010 Chatham House report Beyond the Dollar.a That report included an ambitious proposal to enhance SDRs by including additional currencies in the currency basket and encouraging their wider use in international trans- actions, but it did not include a potential role for gold. The Taskforce therefore investigated to what extent gold-laced SDRs could play a useful role in the international monetary system. The creation of the SDR was the culmination of almost a decade of discussion among the G10 and other members of the IMF in the 1960s. In the final analysis the members of the IMF could not agree whether it should supplement or replace the US dollar, and the terms of the SDR were quite opaque: it became a right to draw on the component convertible currencies rather than a currency in its own right. It was introduced just at a time when inflation and excessive international liquidity were the key problem, so issuing large amounts of new reserve assets was not possible. And in the end, the allocation of SDRs was very limited. Although SDRs never fulfilled the role for which they had originally been intended, they did survive, remaining very much on the sidelines as the international monetary system developed. Today, SDRs function as a unit of account, and they also form a small part of national reserves of the international monetary system. After special allocations in the wake of the global crisis, in 2010 there were SDR 204bn in inter- national reserves, comprising just 3.25% of global foreign-exchange reserves. The valuation of the SDR is based on a weighted basket of international currencies, chosen for their full convertibility with a market-determined exchange rate as well as their importance in international trade, financial flows and foreign-exchange reserves. The SDR basket is thus composed of four currencies: the US dollar (41.9%), the euro (37.4%), the British pound (11.3%) and the Japanese yen (9.4%), with the weights designed to reflect their relative importance in the international monetary system. By having the world’s main currencies in such a basket, the intention was that it could be more stable over time than any one currency on its own – the stability of purchasing power being, after all, the sine qua non of a desirable reserve currency and unit of account (Julius, 2010). In an increasingly multi-polar world in which the United States’ relative economic share is gradually diminishing, reliance on a primary reserve currency exposes the world economy to greater financial instability and risks. Therefore, the development of a multi-currency system in the form of an expanded SDR, backed by the largest economies, could help provide much-needed financial stability to the international monetary system. Because SDRs are subject to restrictions on their use, they would have to be adjusted in various ways to make them more attractive as a central bank reserve asset, as a store of value and as a means of exchange. Expanding the SDR basket of currencies to include the renminbi once it is fully convertible and those of leading developing economies would help make SDRs more representative in a multi-polar world. But other steps would also need to be taken to strengthen the case for making SDRs a viable candidate as an international reserve currency, notably by allowing private-sector transactions in SDRs and developing a credit market in SDRs. Last but not least, current IMF rules and regulations would also have to be modified – a move likely to trigger strong political opposition from some member states. Another consideration is that if SDRs were to become a primary international reserve currency, their supply would need to be expanded or contracted continuously, taking into account key global macroeconomic variables such as GDP and trade levels, inflation, interest rates and unemployment. Such adjustments would be necessary to avoid periods when international liquidity is either excessive or inadequate, but this necessarily raises critical governance 18 issues since the IMF is unlikely to be able to function effectively as a global central bank.

www.chathamhouse.org Is There a Role for Gold?

As things stand, the total stock of SDRs is not large enough to make any impact on the fundamental imbalances in the world economy or to provide a significant alternative to US dollar-denominated assets in central bank reserves. For the SDR to become an alternative reserve currency, not only would total issuance need to be greatly increased, but it would need to be liquid and marketable. To develop a gold-laced SDR into a credible international reserve currency, however, would first require altering the IMF’s Articles of Agreement: at present no country is able to base its currency on gold and the IMF is not allowed to use its gold reserves in this way. In effect, since SDRs are everyone’s liability and gold is not part of any currency’s base, bullion could not be made part of SDRs. Although modifying the Articles of Agreement may be achievable, it would no doubt take time to gain sufficient support from member countries to make such far-reaching changes to the IMF’s rules and regulations. Some gold proponents argue that a ‘hard SDR’ version would have to be created with additional backing and arrangements to become an alternative reserve currency (Saidi and Scacciavillani, 2010). This would involve creating a new SDR basket which included an asset, such as gold, whose value is largely uncorrelated with the value of fiat currencies. A ‘hard SDR’ in which gold would account for up to 25% of the basket would require a proportional adjustment in the actual weights and currency amounts of the dollar, the euro, the pound and the yen (Saidi and Scacciavillani, 2011). However, as SDRs are a right to claim reserve currencies from IMF member countries, their utility depends on the willingness of Fund members to accept them. If they were ‘gold-laced’, the liability of the countries that undertake to provide US dollars and other leading currencies in exchange for SDRs would be dependent on the price of gold. The behavioural pattern of the price of gold means that such liabilities would increase in money value just at the time when they were hardest to meet. As a result, it is likely that the countries that provide liquidity to SDRs would resist the inclusion of gold in the basket, and their resistance would be decisive since they are essential to the functioning of the SDR scheme. In fact, a policy change of this nature involving gold would be likely to have the unintended consequence of undermining the willingness of countries to underwrite an expanded SDR basket. Resistance to creating a gold-laced SDR, let alone a ‘hard SDR’, to rival the US dollar as a global reserve currency would no doubt be considerable, particularly among policy-makers in the United States. Although the Taskforce acknowledged that expanding the SDR basket could help strengthen the international monetary system as the transition to a multi-polar world leads to greater volatility, it concluded there was little available research that a gold- laced SDR would bring additional benefits.

a For further details see Williamson (2009), Mateos y Lago et al. (2009) and Ocampo (2009).

4.3 Gold as a hedge or safe haven net buyers, rather than net sellers, of bullion. This trend continued in 2011, as Figure 4.3 shows. The Taskforce also examined the role of gold as a hedge The vast majority of this activity has been by the central banks or a safe haven. Although gold has no formal position in of developing countries, which have traditionally held little the international monetary system today, it nonetheless or no gold in their foreign-exchange reserves. As Table 4.1 continues to play an important role, constituting about 12% highlights, their gold holdings still account for a very small of international reserves. In recent years, that percentage percentage of foreign-exchange reserves compared with many has been rising, not only because the price of gold has developed economies, even though a number of developing 19 increased, but also because central banks have become countries have been steadily accumulating gold reserves.

www.chathamhouse.org Gold and the International Monetary System

Figure 4.3: Net central bank gold sales

800

600

400

200 Tonnes 2010 2011* 0 2001 2002 2003 2004 2005 2006 2007 2008 2009

-200

-400

Source: GFMS. *Q1–Q3 2011.

Nonetheless, the global stock of gold held as reserves by risk in holding gold. A key drawback of gold is that it central banks (about $1.4trn, excluding the IMF and the generates no interest return, but if actively used, gold Bank for International Settlements as of Q3 2011) is just reserves can generate positive returns in a rising market. a fraction (even at current prices) of today’s global stock Indeed, a number of central banks in search of higher of money. According to recent money supply (M2) data returns have engaged in gold lending, gold swaps and (i.e. currency and deposits) released by the Federal collateralized borrowing. Reserve, the stock of money in the United States alone In the past few years, there has been a tangible shift in totals about $9.7trn, or about seven times the global stock the behaviour of central banks when it comes to managing of gold reserves. their reserves. At present, as noted above, the dollar is still It is far from clear what proportion of gold is optimal the primary reserve currency, with the euro, the yen and in a central bank’s reserve portfolio, as it will depend on the pound all considered less attractive options, and the a number of factors: the size of the reserves and their renminbi still to achieve full convertibility. However, a adequacy for daily needs; whether the country is a gold persistent dissatisfaction with the ability of the dollar to producer; the central bank’s risk tolerance, confidence in maintain its value has led to some diversification. In the fiat currencies and its views of future price movements. past decade, there has been an enormous accumulation However, a consensus seems to be emerging among the in foreign-exchange reserves, which has coincided with newly asset-rich countries that having some bullion a dramatic shift in the balance held by developed and should increasingly become a key part of their long-term developing countries. Whereas in 2000 reserves held by strategy. developed economies ($1.2trn) were almost double those Indeed, asset-rich central banks that have been buying of emerging-market economies ($0.7trn), by the first gold see it as a useful way to diversify their holdings, quarter of 2010 the reverse had become true, with the latter reduce their exposure to US dollars and protect them- having accumulated $5.5trn, compared with just $2.8trn in selves against tail risks – really bad outcomes such as the developed world. Since then, as Figure 4.4 demon- hyper-inflation or sovereign default – but there are strates, central banks have continued to stockpile foreign- other reasons as well. The traditional view of gold as the exchange reserves, with the total rising to an estimated 20 ultimate asset still carries weight and there is no default $10trn in 2011, including about $3.2trn by China alone.

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Table 4.1: Gold holdings and forex reserves, Quarter 2, 2011

Country GDP Gold Gold FX reserves Total reserves Gold Gold Total reserves (USD millions) (tonnes) (USD millions) (USD millions) (USD millions) as a share of as a share as a share of total reserves of GDP GDP (%) (%) (%)

United States 14526550 8133.5 393686.6 136,618.9 530,305.5 74.2 2.7 3.7

China 5878257 1054.1 51021.4 3,219,760.5 3,270,781.9 1.6 0.9 55.6

Japan 5458797 765.2 37039.0 1,100,758.8 1,137,797.8 3.3 0.7 20.8

Germany 3286451 3401.0 164617.4 66,004.6 230,622.0 71.4 5.0 7.0

France 2562742 2435.4 117882.2 60,253.3 178,135.4 66.2 4.6 7.0

United Kingdom 2250209 310.3 15017.4 79,662.6 94,680.0 15.9 0.7 4.2

Brazil 2090314 33.6 1626.6 334,143.7 335,770.4 0.5 0.1 16.1

Italy 2055114 2451.8 118677.1 48,090.7 166,767.8 71.2 5.8 8.1

India 1631970 557.7 26996.8 291,724.5 318,721.2 8.5 1.7 19.5

Canada 1577040 3.4 164.1 62,324.1 62,488.2 0.3 0.0 4.0

Russia 1479825 836.7 40499.5 484,004.5 524,503.9 7.7 2.7 35.4

Spain 1409946 281.6 13630.8 20,268.1 33,898.9 40.2 1.0 2.4

Australia 1237363 79.9 3865.2 40,318.5 44,183.7 8.7 0.3 3.6

Mexico 1034308 105.9 5124.9 128,767.6 133,892.4 3.8 0.5 12.9

Korea 1014482 39.4 1908.9 309,454.9 311,363.8 0.6 0.2 30.7

Netherlands 780668 612.5 29644.8 20,712.6 50,357.4 58.9 3.8 6.5

Turkey 735487 116.1 5619.8 93,737.1 99,356.9 5.7 0.8 13.5

Indonesia 706752 73.1 3537.9 116,130.2 119,668.2 3.0 0.5 16.9

Switzerland 527920 1040.1 50342.9 240,063.8 290,406.7 17.3 9.5 55.0

Poland 469401 102.9 4981.6 104,138.7 109,120.3 4.6 1.1 23.2

Belgium 467779 227.5 11011.2 17,825.3 28,836.5 38.2 2.4 6.2

Sweden 458725 125.7 6085.4 44,844.3 50,929.7 11.9 1.3 11.1

Saudi Arabia 448360 322.9 15629.6 496,859.0 512,488.6 3.0 3.5 114.3

China, 429845 423.6 20504.9 398,603.3 419,108.2 4.9 4.8 97.5

Sources: IMF, and Chatham House calculations.

Figure 4.4: Foreign-exchange reserves of advanced and developing economies

12,000 Emerging and developing economies Advanced economies 10,000

8,000

6,000 USD billions 4,000

2,000

0

1999 Q11999 Q32000 Q12000 Q32001 Q12001 Q32002 Q12002 Q32003 Q12003 Q32004 Q12004 Q32005 Q12005 Q32006 Q12006 Q32007 Q12007 Q32008 Q12008 Q32009 Q12009 Q32010 Q12010 Q32011 Q1

Source: IMF, Currency Composition of Official Foreign Exchange Reserves (COFER). 21

www.chathamhouse.org Gold and the International Monetary System

Figure 4.5: Gold reserves by country, Quarter 2, 2011

9,000

8,000

7,000

6,000

5,000

4,000 Metric tonnes 3,000

2,000

1,000

0 India Netherlands Japan Switzerland China France Italy Germany US

Source: World Gold Council.

Gold, however, has continued to form an important hold only a small proportion of gold in their reserves, but proportion of the foreign reserves of several major developed they have significantly increased the size of their holdings economies. The United States holds by far the most gold of in the past decade as their total reserves have increased. any nation, as Figure 4.5 shows, with 8,134 metric tonnes Since the onset of the financial crisis, the central banks out of a world total of 30,717 metric tonnes, which amounts of some smaller emerging markets including Sri Lanka, to 74% of its total foreign reserves. But a number of other Mauritius and Bangladesh also have significantly increased developed countries have also maintained the lion’s share of their purchases of gold. Both Sri Lanka and Mauritius have their reserves in gold, including Germany with 3,401 metric more than quadrupled their gold holdings since mid-2007 tonnes (71%), Italy with 2,452 metric tonnes (71%) and and in the case of Bangladesh, the rise has been nearly France with 2,435 metric tonnes (66%). This reflects statutory nine-fold.42 Indeed, in a number of developing countries, requirements as well as the legacy of the Bretton Woods era. gold is starting to play a more important role in their Leading developing and emerging-market economies reserve management strategies – even under a system built such as China (1.6%), India (8.5%) and Russia (7.7%) on fiat money (see Figure 4.6).

Figure 4.6: Gold as % of reserves, Quarter 2, 2011

14

12

10

8

Percentage 6

4

2

0 China Russia India

Source: World Gold Council.

22

42 Data from World Gold Council (October 2011).

www.chathamhouse.org States would have then to pay greater attention to the If providers so, currency reserve such as United the as apredictorserve of future inflation Figure (see 4.7). fashion to way the benchmark 10-year US bond yields heating or as an early warning of recession, insimilar system as aproxy indicator ofeconomic global over to play amore formal role international inthe monetary risks. In narrow this it sense, might possible for be gold markets perceive bullion as an insurance against tail and demand for gold may indicate extent the to which a hedge against depreciation. currency The levelprice soared, inorder and to provide diversify reserves their price the evenwhen increasedof them, cases bullion has havebanks held onto and gold their insome reserves Source: US Bureau of Labor StatisticsandFederal USBureauofLabor Reserve. Source: Source: IMF InternationalFinancialStatistics. IMF Source: Figure 4.7:10-yearbondyieldsandinflation Figure 4.8:Monthlyevolutionofgoldprices In of times recent economic turmoil, most central

US Dollars Percentage 10 1,800 1,000 1,200 1,400 1,600 2,000 -4 -2 0 2 4 6 8 200 400 600 800 1970 0 1992

1972 1993

1974 1994

1976 1995

1978

1996

1980

1997

1982

1998

1984

1999

1986

2000 1988

2001 - 1990

2002 1992 lingeringthe sovereign debt of woes eurozone. the market concerns as financial the crisis broke, followed by short of $700/oz, as Figure rise 4.8highlights.This reflected price the mid-2007, when of gold hovering was still well itself. But much of sharp this increase has place taken since $1,750/oz by end-January 2012)has in become astory $1,900/oz inearly September 2011(before settling at around pricethe of gold from $279/oz at of end-2001 to apeak its appeal and to led asurge inits price. in The rise sharp previousthe year. Its safe-haven properties have to added investment demand in gold doubling virtually in 2008 from attractive investment option among private investors, with policies. andmonetary fiscal behaviour of gold the market informulating their Since financial the crisis, goldbecome has evenan more

2003 1994

2004 1996

2005 1998

2006 2000

2002 2007

2004 2008 Is ThereaRoleforGold? 10-year bond yield US inflationrate www.chathamhouse.org 2006 2009

2008 2010

2010 2011

2012 2012 23 Gold and the International Monetary System

Figure 4.9: Monthly evolution of gold prices (real, 2007 dollars)

2,000

1,800

1,600

1,400

1,200

1,000

US Dollars 800 Long-term average $626.7 600

400

200

0

1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Source: IMF International Financial Statistics, US Bureau of Labor Statistics and Chatham House calculations.

One widely held argument for a renewed role for gold Federal Reserve, , said at a Congressional in the international monetary system is that its counter- hearing in July 2011, ‘I think the reason people hold gold is cyclical qualities can serve as a hedge against specific as protection against what we call “tail risk” – really, really risks, such as bouts of inflation or financial contagion. The bad outcomes. To the extent that the last few years have Taskforce, however, was not convinced and found that made people more worried about the potential of a major there are also times when its usefulness as a hedge is rather crisis, then they have gold as a protection.’43 limited and that its counter-cyclical qualities are incon- Gold will therefore continue to be an attractive asset sistent over time and across asset classes (Kendall, 2011). even when particular paper assets have lost value. However, Gold’s traditional role as a hedge is reflected by the the drawback is that its price tends to be highly volatile behaviour of investors who have flocked to gold in search compared with other reserve assets and it generates no yield of a safe haven, notably as a hedge against declining (other than capital gains, which are only realized when it values of the US dollar and other key fiat currencies. is sold). It can therefore have some utility in a portfolio of The dramatic rise in price has also drawn in speculators assets by spreading valuation risk, but at the same time it looking for a quicker return. As the Chairman of the would not be very effective as a sole reserve asset.

Box 4.2: Digital gold currency

The search for new means of payment, spearheaded by advances in technology, led to a flurry of activity in the field of digital gold currency in the late 1990s. Since then, however, the track record of digital gold, a form of electronic money based on ounces of gold enabling users to pay each other in units that hold the same value as bullion, has been – to say the least – a mixed success. Digital gold advocates claim that it offers a truly global and borderless world currency system which is independent of exchange-rate variations and political manipulation. Unlike fractional reserve banking (where

24 43 See Capie et al. (2005) and Sommer J., ‘In a Gold Lovefest, Shades of 1980’, New York Times, 23 July 2011.

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banks maintain reserves that are only a fraction of the customers' deposits), digital gold schemes hold 100% of clients’ funds in reserve as gold or other precious metals which can then be exchanged via digital certificates. Digital gold proponents also claim that deposits are protected against inflation, devaluation and other risks inherent in fiat currencies, but the industry has had its share of problems. Several digital gold companies such as OS-Gold, Standard Reserve and INTGold were launched and failed between 1999 and 2004, while in 2007 the United States Department of Justice indicted the proprietors of one prominent firm, e-gold Ltd., on four counts of violating money-laundering regulations, before it was forced to suspend all operations in 2009. Although the digital gold industry is certainly not alone in the financial services arena to suffer from similar problems, such setbacks have raised serious doubts about this sector’s ability to establish itself as a nascent but potentially credible alternative to fiat currencies. Nonetheless, at a time when there are heightened concerns about the effectiveness of the international monetary system, and growing risks of recession and deflation, this could be an opportunity for non-state money to develop. Despite an inauspicious start, digital gold currency could be well placed to benefit from further advances in technology and innovation. The technological development that has facilitated electronic payments was the GSM technology that allowed the creation of a network covering all mobile phone users in the world. With handset compatibility, digital value could now be transferred from one phone to the other. But to evolve as money, digital gold’s marginal cost of acquiring information would need to fall. Indeed, paper money took root as a means of lowering transaction costs and it would be essential for digital gold to lower these costs still further. For digital gold currency to become more widely established and to be considered a viable alternative not only to fiat currencies but to fiat electronic currencies as well, its design must possess all the features of a secure means-of-payment system. The inclusion of gold has given the system a degree of credibility, and in a practical sense digital gold currency has many of the attributes that are required, starting with acceptability and portability. It also has the advantage that it is divisible, allowing transactions of any value to take place, and its homogeneity is important in order to avoid confusion. Moreover, digital gold currency offers recognizability, ensuring there is no need for special expertise in identifying the money, while advances in cryptography can make digital gold very difficult to forge. However, being a non-fractional reserve system is a limitation, notably its inherent lack of liquidity. Therefore, a precondition for extending the popularity of a digital gold currency is a growth in confidence among users to the point where they would be prepared to accept a form of fractional reserve system whereby some fraction of the gold stored serves as backing for a much larger payment service. To boost confidence in the system, particularly in the light of the fraudulent activities of some in the industry, as well as other risks such as data security, the Global Digital Currency Association – a non-profit association of online currency operators, exchangers, merchants and users – was established in 2002. This was the industry’s first attempt at self-regulation, but the results so far have been underwhelming. To transform digital gold from a niche market to one that achieves wider acceptability, an independent central settlement agency or clearing house would need to be created to standardize the different digital gold schemes and help play a key regulatory role. Otherwise, it is difficult to see how digital gold could ever challenge the position of traditional fiat currencies, even at a time when their effectiveness in the international monetary system is being openly questioned.

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www.chathamhouse.org Gold and the International Monetary System

4.4 Gold as collateral banks withdrew 635 metric tonnes of gold in the year to end-March 2011. This represented the largest withdrawal of In the wake of the European sovereign debt crisis and the gold in more than a decade, prompting the BIS to acknowl- rapidly declining value of high-quality collateral, a growing edge that the fall in the value of gold deposits reflected ‘a number of clearing houses and financial institutions shift in customer gold holdings away from the BIS’.45 have begun using gold as collateral to back transactions It is somewhat uncertain whether these two actions were processed through them by traders. With investors increas- related in central banks making more active use of their ingly perceiving gold as a safe haven asset in the face of gold holdings. While elevated credit risks and increasing severe market turmoil, several clearing houses such as concerns about tail risks have increased the usage of LCH.Clearnet, CME Group, and IntercontinentalExchange gold amongst central banks and by a growing number of – which typically use cash and government bonds as exchanges, the Taskforce found limited research that would security – have introduced the use of bullion in recent years. indicate that gold can play a more official role than it already An interview with a clearing house revealed its reasoning does, as collateral in the international monetary system. for gold’s inclusion as an acceptable collateral source was twofold: to diversify their own collateral pool, and customer demand from gold holders who wanted to make use of their 4.5 Gold as a policy indicator gold while still maintaining their long position.44 Likewise, JPMorgan has begun accepting gold to satisfy The jury is still out on whether gold could play an even collateral requirements in repo transactions, which would more significant role in the international monetary system allow banks to use bullion as security when lending to each by serving, for example, as a policy indicator or trigger for other. Banks have also begun charging more for storing decision-making. The price of gold tends to rise whenever gold, reflecting the enormous surge in demand for assets there are signs of disorder in the fiat money-based interna- that are seen as safe. In the UK, almost all the bullion- tional monetary system, but the Taskforce concluded that dealing banks raised their fees in 2011, in some cases more the extent to which it could be used by decision-makers as than doubling the rates they charge for vaulting gold, as a signal for policy changes is questionable. storage space was put at a premium. Much of the growing The historical behaviour of the gold price does not demand came from exchange traded funds (ETFs), which provide a particularly good indicator for monetary and collectively now hold more gold than most central banks. fiscal policy (see Table 4.2). Gold correctly indicated that The Bank for International Settlements (BIS), the the United States needed tighter monetary policy in the so-called ‘bank for central banks’, has also been more 1960s and in the late 1970s (actually, the price peaked in involved in the gold market in the past two years. In 2011, January 1980, a few months after the crucial tightening of gold reserves of the BIS increased abruptly and signifi- US monetary policy had been initiated). However, the price cantly, just as the European debt crisis began. The BIS did fall of about one-third between 1996 and 2001 did not fore- not disclose why its reserves increased beyond stating they shadow a period of weak growth and any need for policy were part of some customer swaps. However media reports easing. In fact, US fiscal policy was tightened sharply over and discussions with bullion banks suggested that troubled that period, and there were budgetary surpluses in 1999 and commercial banks were swapping gold with the BIS’ central 2000, without any apparent damage to the US economy. bank customers to raise cheaper funding at the beginning Even more recently, the rise in the gold price since the onset of the European sovereign debt crisis. For central banks of the financial crisis in 2007 would have been thought by this was a way to lend cash against a high-quality collat- policy-makers to indicate a need for tighter policies which, eral like gold. More recently, BIS data revealed that central if implemented, could have been deeply damaging.

26 44 “Gold as a Source of Collateral”, World Gold Council, 2011. 45 Farchy J., 'Central banks pull most gold bullion in a decade from BIS', Financial Times, 8 July 2011.

www.chathamhouse.org Is There a Role for Gold?

Table 4.2: Has gold influenced policy?

Time period Episode What did it indicate? Did it influence policy?

Concern about US external deficit. Tighter US 1960s US gold losses No. Bretton Woods collapsed. monetary and fiscal policy.

No. Monetary policy was tightened, but 1979–80 Price rise Concern about inflation. Tighter monetary policy. not because of gold.

Early 2000s Price fall Confidence about inflation and outlook for growth. No.

2007–11 Price rise Concern about bank solvency and US deficit. No.

Source: Allen (2011).

Some gold analysts argue that bullion prices are cators. Nor did gold prices correlate closely with a host of a good proxy for key macroeconomic variables, and typical leading indicators, such as industrial output and therefore should be preferred as an indicator or measure real GDP growth, inflation rates, global trade volumes, of global economic overheating or underperformance. housing starts, consumer and business confidence surveys The Taskforce did find that in certain periods gold prices or stock market prices. Therefore, in terms of using gold correlated to some of these events; and they also found price movements as an indicator on how to adjust liquidity a correlation at certain times with other commodity in the international monetary system, gold was rarely prices. However, neither gold nor commodity prices more found to be a good proxy for key macroeconomic indica- broadly appeared particularly effective as economic indi- tors to support such decisions.

27

www.chathamhouse.org economy back on track and create a framework for greater financial stability in the future, and with it the restoration of sustained economic growth. In the light of the long-term weakness of the US dollar, the Taskforce explored whether gold could again serve as 5. Taskforce an anchor to back the value of the primary reserve currency, particularly in times of crisis. Drawing on Conclusions the lessons of the Gold Standard era and the Bretton Woods experience, the Taskforce concluded that the reintroduction of gold as an anchor would not only be impractical; it could even be damaging, given its deflationary bias. • There is no clear-cut role for gold as a policy indicator, The debate on how to address the myriad challenges despite what some gold analysts believe. Indeed, the facing the international monetary system often evokes historical behaviour of the gold price does not provide strong emotions across the policy spectrum, but even a particularly good indicator for either monetary or sharper reactions are usually triggered when gold finds its fiscal policy. In fact, since the financial crisis, the rise way into the discussion. The Chatham House Taskforce, in the gold price has indicated the need for tighter therefore, was mindful to take a step back from the hype, policies which, had they been implemented, could working hard to keep an open-minded approach in its have been deeply damaging. To an extent, gold does deliberations while carrying out a thorough examination play a limited indicator role today since the price of the role gold already plays or could play once again in rise reflects a lack of market confidence in the future an ever more complex international monetary system. value of key currencies and the low return on other Not since the 1982 US Commission on the Role of Gold financial assets. But the Taskforce found no consistent in the Domestic and International Monetary Systems had and reliable correlation between bullion and a host a prominent policy group of experts made a serious and of key economic variables that could be used to extensive assessment of bullion and the monetary system. inform policy decision-making. As a general guide At the time, the Commission concluded that the flex- for adjusting liquidity in the international monetary ibility of the post-Bretton Woods era was preferable to system, therefore, gold was not found to be a good endorsing a formal role for gold. Likewise, the Chatham proxy for key macroeconomic indicators. House Taskforce stopped short of making specific proposals • Since the onset of the financial crisis, gold has been or recommendations regarding a potential comeback for propelled into the spotlight, with both central banks gold in the international monetary system, but its in-depth and investors viewing bullion as a hedge against discussions and written contributions spanning an eight- specific risks such as inflation and financial contagion, month period nonetheless generated thought-provoking and as a store of value. Gold has indeed served as a and innovative perspectives,46 from which a number of key useful hedge against declining values of the US dollar conclusions emerged. and other key fiat currencies, and it has become an element in central banks’ quest for foreign reserves • The current financial crisis has highlighted the diversification. But its role as a hedge comes at a cost. urgency of addressing deficiencies in the interna- Gold will continue to be a valuable asset even when tional monetary system in order to get the world particular paper assets have lost value; however, the

28 46 See Chatham House website for published Taskforce papers: http://www.chathamhouse.org/research/international-economics/current-projects/gold- and-international-monetary-system..

www.chathamhouse.org Taskforce Conclusions

disadvantage is that its price is often quite volatile • In the transition to an increasingly multi-polar world compared with other reserve assets and it generates in which interdependence is the norm and the United no yield. It can therefore have some utility in a States’ hegemony is steadily being challenged, the portfolio of assets by spreading valuation risk but, on global economy is likely to face periods of volatility the other hand, it would not be very effective as a sole and uncertainty. Gold can thus be expected to continue reserve asset. playing a significant role in the international monetary • Although an intriguing idea was considered by the system, serving as a valuable hedge and safe haven, Taskforce – to expand the IMF’s SDRs basket to particularly in times when tail risks predominate. include gold – the proposal failed to convince most • For gold to play a more formal role in the interna- members of the group that this would actually bolster tional monetary system, it would be imperative for the international monetary system. In future, adding it neither to hamper the system’s performance nor to currencies from key developing countries, such as create unacceptable constraints on national economic China, was thought to be desirable by many Taskforce policies. The discipline imposed by a gold standard on members to better reflect their growing importance monetary policy might have served as a brake on the in the world economy. But the Taskforce found little imprudent banking and massive debt accumulation evidence that also including gold in the basket would of the past decade, but it is likely that the inflexibility bring substantial benefits and, on the contrary, of a fixed price for gold would have been a serious concluded that it might actually be an obstacle to drawback with the onset of the financial crisis when reform. a far more flexible monetary response was required.

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www.chathamhouse.org Cohen, Benjamin (2010), The Future of Global Currency: The Euro versus the Dollar (London: Routledge). Dooley, Michael P., David Folkerts-Landau and Peter M. Garber (2004), ‘The Revived Bretton Woods System’, International Journal of Finance and Economics, 9: 307–13, available at http://web.ku.edu/~intecon/ References Read/Dooley04.pdf. Dooley, Michael P., David Folkerts-Landau and Peter M. Garber (2009), ‘Bretton Woods II Still Defines the International Monetary System’, NBER Working Paper 14731, February, available at http://www.nber. org/papers/w14731.pdf. Asian Development Bank (2011), ‘Asian Development Driffill, John (2010), ‘The Fall-back Position’, in Paola Outlook 2011’, Asian Development Bank, available Subacchi and John Driffill (eds), Beyond the Dollar: at http://beta.adb.org/publications/asian-development- Rethinking the International Monetary System, Chatham outlook-2011-south-south-economic-links. House Report. Aliber, Robert Z. (1966), The Future of the Dollar as an Eichengreen, Barry (1992), Golden Fetters: The Gold International Currency (New York: Frederick Praeger). Standard and the Great Depression, 1919–1939 (New Allen, William A. (2011), ‘Drivers of central bank demand York: Oxford University Press). for gold and gold’s use as an indicator’, Chatham House Eichengreen, Barry (2010), ‘The Renminbi as an Gold Taskforce external consultation, October, see International Currency’, University of California, Chatham House website for published Taskforce papers: Berkeley, available at http://www.econ.berkeley.edu/ http://www.chathamhouse.org/research/international- ~eichengr/renminbi_international_1-2011.pdf. economics/current-projects/gold-and-international- Eichengreen, Barry and Marc Flandreau (2009), ‘The Rise monetary-system. and Fall of the Dollar (or When Did the Dollar Replace Allen, William A. and Richhild Moessner (2011), ‘The Sterling as the Leading Reserve Currency?)’, European international propagation of the financial crisis of 2008 Review of Economic History 13: 377–411. and a comparison with 1931’, Monetary and Economic Farhi, Emmanuel, Pierre-Olivier Gourinchas and Hélène Department, BIS Working Papers No. 348, July. Rey (2011), ‘Reforming the International Monetary System’, Bernanke, Ben (1995), ‘The Macroeconomics of the Great Centre for Economic Policy Research 2011 (eBook): ISBN Depression: A Comparative Approach,’ Journal of 978-1-907142-41-3, available at http://www.cepr.org/pubs/ Money, Credit and Banking 27(1): 1–28. books/cepr/Reforming_the_International_Monetary_ Bernanke, Ben and Harold James (1991), ‘The Gold System.pdf. Standard, Deflation, and Financial Crisis in the Great Fosler, Gail (2011a), ‘Why Gold?’, The Gail Fosler Group Depression: An International Comparison’, in R. G. LLC, 13 September, available at http://www.gailfosler. Hubbard (ed.), Financial Markets and Financial Crises com/commentary/why-gold. (University of Chicago Press). Fosler, Gail (2011b), ‘The International Monetary System vs. Bordo, Michael D. and Hugh Rockoff (1996), ‘The Gold the International Financial System and the Significance Standard as a “Good Housekeeping Seal of Approval”’, for Policy Makers’, Chatham House, December 2011, see Journal of Economic History 56 (2): 389–428. Chatham House website for published Taskforce papers: Capie F., T. Mills and G. Wood (2005), ‘Gold as a Hedge http://www.chathamhouse.org/research/international- against the Dollar’, Journal of International /current-projects/gold-and-international- 30 Markets and Institutions and Money, 2005. monetary-system.

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Glick, Reuven (2011), ‘Reserve Currency Issues’, Center Rethinking the International Monetary System, Chatham for Pacific Basin Studies Federal Reserve Bank of San House Report. Francisco, Presentation at the WBI/FRBSF/BIS/BOE/ Kendall, Tom (2011), ‘Gold: Cycles & Bubbles’, Chatham BOK/MSF Policy Seminar, 'Managing Capital Flows and House Gold Taskforce external consultation, October, Growth in the Aftermath of the Global Crisis', Seoul, see Chatham House website for published Taskforce Korea, 23–26 May, available at http://wbi.worldbank. papers: http://www.chathamhouse.org/research/inter- org/wbi/Data/wbi/wbicms/files/drupal-acquia/wbi/ national-economics/current-projects/gold-and-interna- Reserve_Currency_Issues-ReuvenGlick.pdf. tional-monetary-system. Golley, Jane and Ligang Song (eds) (2011), Rising China: Kenen, Peter B. (2010), ‘Reforming the Global Reserve Global Challenges and Opportunities (Canberra: Regime: The Role of a Substitution Account’, International Australian National University Press). Finance 13(1): 1–23, 03. Goodburn, Peter (2011), ‘Gold as a Financial Anchor?’, Kenen, Peter B., Francesco Pappadia and Fabrizio The Gail Fosler Group LLC, September, available at Saccomani (eds) (1994), The International Monetary http://www.gailfosler.com/featured/gold-as-a-financial- System (Cambridge University Press). anchor. Keynes, John Maynard (1923), A Tract on Monetary HSBC (2011), ‘RMB FDI Formalization’, HSBC Global Reform (London: Macmillan and Co.) Research, 14 October, available at http://www.research. Keynes, John Maynard (1924), Monetary Reform (New hsbc.com/midas/Res/RDV?p=pdf&key=ELS3s1Yz York: Harcourt, Brace). WX&n=310451.PDF. Kisch, Cecil (1931), ‘The Gold Problem’, paper delivered IMF (2010), ‘Review of the Method of Valuation of at Chatham House, 19 January, available at http://www. the SDR’, prepared by the Finance Department, in chathamhouse.org/sites/default/files/public/Research/ consultation with the Legal and Other Departments, International%20Economics/1931kisch.pdf. Approved by Andrew Tweedie, 26 October, available at Krugman, Paul (1984), ‘The International Role of the http://www.imf.org/external/np/pp/eng/2010/102610. Dollar: Theory and Prospect,’ in J. F. O. Bilson and R. pdf. C. Marston (eds), Exchange Rate Theory and Practice IMF (2011a), ‘Criteria for Broadening the SDR Currency (University of Chicago Press). Basket’, prepared by the Finance and Strategy, Policy, Mateos y Lago, Isabelle, Rupa Duttagupta and Rishi Goyal and Review Departments, in consultation with other (2009), ‘The Debate on the International Monetary departments, approved by Andrew Tweedie and Reza System’, IMF Staff Position Note, November, SPN/09/26. Moghadam, 23 September, available at http://www.imf. Nugée, John (2010), ‘Reconsidering the Reserve Currency org/external/np/pp/eng/2011/092311.pdf. Question’, in Paola Subacchi and John Driffill (eds), IMF (2011b), ‘IMF Executive Board Discusses Criteria Beyond the Dollar: Rethinking the International Monetary for Broadening the SDR Currency Basket’, Public System, Chatham House Report. Information Notice (PIN) No. 11/137, 11 November, Ocampo, José Antonio (2009), ‘Special Drawing Rights available at http://www.imf.org/external/np/sec/ and the Reform of the Global Reserve System’, G24 pn/2011/pn11137.htm. Intergovernmental Group of Twenty-four. IMF (2012), ‘Money Matters: An IMF Exhibit – The Royal Institute of International Affairs Study Group (1931), Importance of Global Cooperation, System in Crisis ‘Collected Papers 1929–30, The International Gold (1959–1971)’, viewed 9 January 2012, available at Problem: A Record of the Discussions of a Study Group http://www.imf.org/external/np/exr/center/mm/eng/ of Members of the Royal Institute of International mm_sc_03.htm. Affairs’, Chatham House, available at http://www. Julius, D. (2010), ‘A Roadmap for SDR Evolution’, in Paola chathamhouse.org/publications/papers/view/178235. 31 Subacchi and John Driffill (eds), Beyond the Dollar: Saidi, Nasser and Fabio Scacciavillani (2010), ‘The Role of

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Gold in the New Financial Architecture’, Economic Note Subacchi, Paola and John Driffill (eds) (2010), Beyond the No. 13, Dubai International Financial Centre, December. Dollar: Rethinking the International Monetary System, Saidi, Nasser, Aathira Prasad and Sara Salomoni (2011), Chatham House Report, March, available at http://www. ‘The Redback Cometh: Renminbi Internationalisation chathamhouse.org/publications/papers/view/109263. & What To Do About It’, Economic Note No. 18, Dubai Subacchi, Paola and Paul Jenkins (2011), Preventing International Financial Centre, December, available Crises and Promoting Economic Growth: A Framework at http://www.difc.ae/sites/default/files/economic- for International Policy Cooperation, Chatham House note-18.pdf. Report, April, available at http://www.chathamhouse. Sarkozy, Nicolas (2010), Speech at the 40th World org/publications/papers/view/109655. Economic Forum Davos, 27 January, available at Subramanian, Arvind (2011), Eclipse: Living in the Shadow https://members.weforum.org/pdf/Sarkozy_en.pdf. of China’s Economic Dominance, Peterson Institute for Sarkozy, Nicolas (2011), Address by Mr Nicolas Sarkozy, International Economics, ISBN 978-0-88132-626-0. Press Conference to present the presidency of the G20 Triffin, Robert (1968), Our International Monetary System: and G8, Elysée Palace, 24 January, available at http:www/ Yesterday, Today and Tomorrow (New York: Random g20-g8.com/g8-g-20/g8/English/for-the-press/speeches/ House). address-by-mr-nicolas-sarkozy-to-present-the.1022. Triffin, Robert (1988), Gold and the Dollar Crisis (New html. Haven, CT: Yale University Press). Schenk, Catherine (2010), The Decline of Sterling: Managing Truman, E. M. (2010), The International Monetary the Retreat of an International Currency 1945–1992 System and Global Imbalances, Peterson Institute for (Cambridge University Press). International Economics. Schenk, Catherine (2011a), ‘Gold as a Money Anchor: We have US Gold Commission (1982), ‘Report to the Congress of been here before’, The Gail Fosler Group LLC, September, the Commission on the Role of Gold in the Domestic available at http://www.gailfosler.com/featured/gold-as-a- and International Monetary Systems’, March. money-anchor-we-have-been-here-before. Williamson, John (2009), ‘Understanding Special Drawing Schenk, Catherine (2011b), ‘Contrasting Challenges: Rights (SDRs)’, Peterson Institute for International The 1930s Chatham House Study Group on “The Economics, Policy Brief, No. PB09-11, June, available at International Gold Problem” and the 2011 Chatham http://www.iie.com/publications/interstitial.cfm?Research House Taskforce on “Gold and the International ID=1231. Monetary System”’, September, Chatham House, World Bank (2011), ‘Global Development Horizons 2011 available at http://www.chathamhouse.org/publications/ – Multipolarity: the New Global Economy’, available at papers/view/178249. http://siteresources.worldbank.org/INTGDH/Resources/ Stiglitz, Joseph E. et al. (2010), The Stiglitz Report: Reforming GDH_CompleteReport2011.pdf. the International Monetary and Financial Systems in the Zhou, Xiaochuan (2009), ‘Reflections on Reforming the Wake of the Global Crisis (New York: The New Press). International Monetary System’, People’s Bank of China, Subacchi, Paola (2010), ‘One Currency, Two Systems’: available at http://www.cfr.org/china/zhou-xiaochuans- China’s Renminbi Strategy, Chatham House Briefing statement-reforming-international-monetary-system/ Paper, IE BP 2010/01, October. p18916.

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www.chathamhouse.org of the Institute of Economic Affairs, on the Council of the Taxpayers Alliance, and an Academician of the Academy of Social Sciences. Between 2004 and 2010 he was on secondment at the Bank of England, writing the latest Appendix 1: instalment of their history, from the 1950s to 1980. Meghnad Desai is Emeritus Professor of Economics at About the Taskforce the London School of Economics. He is an Indian-born British economist and a serving member of the House of Members Lords for the Labour party. He received his PhD from the University of Pennsylvania and has written extensively on a wide range of subjects. From 1984 to1991, he was co-editor of the Journal of Applied Economics. He has been both Chair and President of Islington South and Finsbury Constituency Labour Party in London and was Bill Allen is a visiting senior fellow at the Faculty of made a life peer as Baron Desai, of St Clement Danes Finance, Cass Business School, City University London in the City of Westminster, in April 1991. In 2005 he and a specialist adviser to the House of Commons Treasury retired as Director of the Centre for the Study of Global committee. He was educated at Oxford University and Governance, which he founded in 1992 at the LSE. He the London School of Economics. From 1972 to 2003, was Chairman of Training for Life, Chairman of the he worked at the Bank of England, including as Head Management Board of City Roads and on the Board of of Money Market Operations Division, Head of Foreign Tribune magazine. He is an Honorary Associate of the Exchange Division, Deputy Director, Monetary Analysis, National Secular Society. Deputy Director, Financial Market Operations, and finally (2002–03) as Director for Europe and Deputy Director for Gail D. Fosler is President of the GailFosler Group LLC, Financial Stability. Since 1990, he has provided technical a strategic advisory service providing in-depth analysis of assistance to emerging countries including , Korea, economic, financial and public policy issues and creating South Africa, , Syria and , and has advised new concepts and frameworks for business and govern- the Russian Ministry of Finance. ment leaders. She is also Senior Advisor to the Business Council, and leads its partnership with the Conference Forrest Capie is Emeritus Professor at the CASS Business Board. She was educated at the University of Southern School, City University, London, where he was Professor of California and gained her MBA at New York University. Economic History (1986–2009), Head of the Department During her 20-year career at the Conference Board, of of Banking and Finance (1989–92), and Editor of the which she is a former President and a Trustee, she held Economic History Review (1993–99). He has been a a number of leadership roles dedicated to expanding the British Academy Overseas Fellow at the National Bureau, organization’s intellectual capacity and global expansion. New York (1978), a Visiting Professor at the University As Executive Vice President and Chief Economist, she of Aix-Marseille (1977) and at the London School of directed its economics programme, and was twice named Economics (1992–93), and a Visiting Scholar at the IMF America’s most accurate economic forecaster by The Wall (2000). He has written widely on money, banking, and Street Journal. She served as Deputy Staff Director and trade and commercial policy. He was a member of the Chief Economist of the US Senate Budget Committee and Shadow Chancellor’s advisory panel (1999–2005), and is is a board member of Baxter International and Swiss Re 33 currently a member of the Academic Advisory Council America Holdings.

www.chathamhouse.org Gold and the International Monetary System

Haihong Gao is a professor and director of the Section of at leading international financial firms. He is a member International Finance, and director of the Research Center of numerous panels and committees, including the Panel for International Finance, Institute of World Economics and of Economic Advisors to the Mayor of London and Politics, Chinese Academy of Social Sciences (CASS). She the World Economic Forum’s Global Agenda Council is the standing director of the council of the China Society on Banking and Capital Markets. He is a Fellow of the for Finance and Banking, on the council of the China Society of Business Economists and on the council of the Society of World Economy and director of the council of Royal Economic Society, and a member of the European the China International Finance Society. Educated at Peking Commission’s ‘informal network of leading China experts’. and Durham Universities, whe was a visiting scholar at the He publishes widely on economic and financial issues, University of California at Davis, under the Ford Foundation including regular newspaper columns, and is the author Scholarship, and a past recipient of the British Council of ‘The 2020 Report’, and co-author of the ‘Report Scholarship and the World Bank Youth Fellowship. Her of the Commission on the £ Sterling’. He has twice topped recent publications include Globalization and China: Theory the Sunday Times annual forecasting table. and Trends (with Yu Yonding and Lu Aiguo); Conditions for the RMB to become an International Currency (with Yu Catherine Schenk is Professor of International Economic Yongding); Global Dollar Standard: Challenges for Asian History at the University of Glasgow. She has been visiting Financial Integration (edited); and The RMB Exchange Rate: professor at Hong Kong University and visiting research Policy Options and Risk Prevention from Global Perspective. fellow at the International Monetary Fund and the Hong Kong Institute for Monetary Research. She has published John Gault is the President of John Gault SA, and served widely on international economic relations including the as Managing Director, IED Consultants SA and Chief development of international financial centres, the role Economist of the International Energy Development of Hong Kong in the international banking and financial Corporation (IEDC) group, now part of Petroleum system and the development of the international monetary Corporation. Prior to joining IEDC in Geneva in 1982, he system from 1945. Her most recent works are The Decline was affiliated with the Boston-based energy-consulting firm of Sterling 1945-92 (Cambridge University Press, 2010) and of Jensen Associates, Inc. In a career spanning more than International Economic Relations since 1945 (Routledge, thirty years, Dr Gault has advised clients in the Middle East, 2011). Her current project is on the development of inter- Europe, Japan, and North and South America on a wide national banking regulation since the 1960s. variety of commercial and public policy issues. A graduate of Yale and Harvard Universities, he has taught economics Paola Subacchi is Research Director, International at the American University of Beirut and Bir Zeit University Economics at Chatham House. Her main research interest (West Bank), and is the author of numerous publications is in the functioning and governance of the international concerning taxation and fiscal systems, government price financial and monetary system, with a particular focus regulation, the economics of exhaustible resources, the on post-crisis policy and institutional change. She is a politics of international oil trade, and methods of designing contributor to peer-reviewed journals and current affairs appropriate contractual terms. publications and a regular media commentator on issues of macro-economic importance. Recent publications include Gerard Lyons is the Chief Economist and Group Head of The Euro on the Brink: ‘Multiple’ Crises and Complex Global Research at Standard Chartered, and an Economic Solutions (January 2012); Legitimacy vs Effectiveness: A Advisor to the Board and a Member of the Bank’s Executive Dynamic Approach to Global Governance (September Forum. Previous roles at the Bank include Member of 2011); Preventing Crises and Promoting Economic the Global Markets Management Team and of the Risk Growth (April 2011, co-authored with Paul Jenkins); 34 Management Committee. He previously held senior roles ‘One Currency, Two Systems’: China’s Renminbi Strategy

www.chathamhouse.org About the Taskforce Members

(October 2010); Who Controls the International Monetary graduate of the University of Cambridge, University of System? (May 2010); Beyond the Dollar: Rethinking the Essex and Chinese University of Hong Kong. International Monetary System (March 2010); An Italian national, she studied at Bocconi University in Milan and at the University of Oxford. Rapporteur

Michael Wong is the Chairman of CTRISKS, a credit André Astrow is Director of A&W Consultants (UK) Ltd. rating agency licensed under the Securities and Futures His main areas of expertise and research interest are in Ordinance in Hong Kong. He is widely recognized as a the global economy, sovereign risk and African affairs. A Basel III expert in Asia and is a professor in bank risk political scientist by training, he worked for 20 years at the management at the City University of Hong Kong, where Economist Intelligence Unit (EIU). He led the EIU’s Country he was granted a university-wide Teaching Excellence Analysis division of economists and editors, producing Award. Dr Wong served as a founding member of analysis and forecasts on more than 200 countries. He the FRM Committee of Global Association of Risk was also responsible for its Country Risk Service and Professionals (GARP) in 1998–2002 and helped develop served for many years as the Regional Director for Africa. the examination to be a global standard on risk manage- Before joining the EIU, he was assistant editor of Africa ment education. Before his career in academic research Report magazine at the African-American Institute in New and credit rating, he worked in investment banking for York. He has written extensively on African countries, was more than seven years, heading gold and forex trading. awarded a PhD in Interdisciplinary Studies at the University He has published more than 40 journal articles and of Kent at Canterbury, and published a book, Zimbabwe: A authored/co-authored 12 professional books. He is a Revolution that Lost its Way? (Zed Press, 1983).

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www.chathamhouse.org Appendix 2: Taskforce Meeting Agendas

Chatham House Taskforce on Gold and the International Monetary System

Thursday 14 April 2011, 0800–1030 The University Club of Washington DC 1135 Sixteenth Street, NW, Washington, DC 20036

The main purpose of the meeting is to provide a forum for the discussion, dialogue and conversation on strengths and weak- nesses of the current international monetary system and dialogue on whether, given market properties of gold, there is a potential role for gold in response to the following weaknesses in the international monetary system: reserve accumulation, beyond the traditional motives for holding reserves; exchange rate volatility in the international monetary system; uncertainty about the availability of international liquidity in a financial crisis; large and volatile capital flows; persistent global imbal- ances; absence of good substitutes to the US dollar as a reserve asset. In particular, we hope to discuss issues around the SDR’s potential development in the international monetary system, and whether there should be a role for gold in the SDR.

Dr Paula Subacchi, Chatham House: Opening Remarks Richard Varghese, Chatham House: The return of the ‘gold debate’, problems with the international monetary system, and the terms of reference of the Chatham House Taskforce

Participants Irena Asmundson, Policy and Strategy Department, IMF Wayne Atwell, Managing Director, Casimir Capital Ashish Bhatia, Government Affairs, World Gold Council John Bridges, Managing Director, JP Morgan Lord Desai, Professor Emeritus, London School of Economics Sean Fieler, Equinox Investment Partners and Chairman of the American Principles Project Gail Fosler, President, The Gail Fosler Group LLC Haihong Gao, Senior Fellow, Director of Research Section of International Finance, IWEP, Chinese Academy of Social Sciences* John Gault, President, John Gault S.A. Geneva* Nick Maxwell, International Economics Programme and Outreach Manager, Chatham House George Milling-Stanley, Managing Director, Government Affairs, World Gold Council John D. Mueller, Director of the Economics and Ethics Program of the Ethics and Public Policy Center Rebecca Nelson, US Congressional Research Service Vincent R. Reinhart, Resident Scholar, American Enterprise Institute Dr Nasser H. Saidi, Chief Economist and Head of External Relations at the Dubai International Financial Centre Authority (DIFCA)* Dr Paola Subacchi, Research Director, International Economics, Chatham House 36 Richard Varghese, International Economics Research Assistant, Chatham House

* Participation via teleconference.

www.chathamhouse.org Taskforce Meeting Agendas

Chatham House Taskforce on Gold and the International Monetary System

International Economics Roundtable Discussion Friday 28 October 2011, 0930–1430 Chatham House, 10 St James’s Square, London SW1Y 4LE

Agenda Chair: DeAnne Julius, Chairman, Chatham House

0945–1000 Welcome by the Chair and Introduction

Presenter: Richard Varghese, Chatham House Th e return of the ‘gold debate’, problems with the international monetary system, and the terms of reference of the Chatham House Taskforce

1000–1200 S ession 1: The Value of Gold: Central Banking Perspective on the Use and Performance of Gold

‘I think the reason people hold gold is as protection against what we call “tail risk” – really, really bad outcomes … To the extent that the last few years have made people more worried about the potential of a major crisis, then they have gold as a protection.’ Ben Bernanke, July 2011

Th e price of gold has reached record levels and central banks, particularly in the emerging world, have initiated large gold purchasing programmes. • Does gold behave as a currency? • What is the de facto function of gold within the international monetary system? • Why are central banks in the emerging world buying gold? • How can we expect the gold price and central bank purchasing of gold to respond in plausible scenarios for the global economy over the next five years?

Presenters: J ohn Nugée, Official Institutions Group, State Street Global Advisors Ltd The role of gold in central banking

Martin Fraenkel, former Global Head of Commodities at Crédit Agricole CIB and NM Rothschild and Sons What can a central bank do with gold?

Bill A. Allen, Cass Business School, City University London Drivers of demand from central banks for gold and its use as an informal indicator for central bankers

1230–1415 Session 2: Market Performance of Gold and Policy Implications

P olicy-makers are accused of lacking discipline through the economic growth cycles. However, gold infor- 37 mally plays an indicator role in financial markets and in the monetary system, helping us to identify where in the business cycle we are.

www.chathamhouse.org Gold and the International Monetary System

• Does gold behave as a currency? • What is driving behaviour in the private sector? • What does the gold price indicate and, crucially, is it countercyclical? • How is it different from other commodities and other indicators? • How should policy-makers react to the indicator role of gold and could gold (prices) provide a guide for monetary or fiscal policy?

Presenters: Michael Lewis, Managing Director, Global Head of Commodities Research, Deutsche Bank Market performance of gold and its use as an indicator for financial markets

 John Gault, President, John Gault S.A., Geneva How does the gold price compare to other macroeconomic indicators?

Tom Kendall, Vice President of Commodities Research at Credit Suisse Gold: cycles and bubbles

1415–1430 C hair’s closing comments and summary of discussion

Taskforce on Gold and the International Monetary System

Chatham House and IWEP–CASS Thursday 10 November 2011, 1400–1630 15th Floor, Chinese Academy of Social Sciences (CASS) Building No. 5 Jianguomen Nei Avenue, Dongcheng District, Beijing, PRC

Agenda Chair: Yu Yongding, Academician of the CASS and former member of the Monetary Policy Committee, PBoC

Welcome and introduction Zhang Yuyan, Director-general, IWEP, CASS

Dr Paola Subacchi, Research Director, International Economics, Chatham House Problems with the IMS, and return of the gold debate, role of the Chatham House Gold Taskforce

Introductory comments Stephen Green, Head of Research, Greater China Global Research, Financial Markets, Standard Chartered Central banks in emerging economies use of gold and the Standard Chartered Gold Super Cycle report Roundtable discussion, covering: • Problems with the IMS, and return of the gold debate; role of the Chatham House Gold Taskforce • Use of gold by central banks in emerging economies • Drivers of China’s accumulation of gold as a reserve asset 38

www.chathamhouse.org Taskforce Meeting Agendas

Professor Catherine Schenk, Professor of International Economic History, School of Social and Political Sciences, University of Glasgow Gold in the SDR proposal and analysis of what it would mean

Dr Michael Wong, City University Hong Kong Gold as an element in the internationalization of the RMB

Roundtable discussion, covering: • Perspective on whether we need more ‘discipline’ in the international monetary system, and what kind of discipline, and for whom, and whether gold could play a role • Gold as an element in the internationalization of the RMB • Gold in the SDR proposal

Closing remarks Yu Yongding, Academician of the CASS and former member of the Monetary Policy Committee, PBoC

All meetings were held under the Chatham House Rule.

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www.chathamhouse.org Gold and the International Monetary System

International Economics at Chatham House

International Economics at Chatham House produces policy-oriented Current research explores the prospects for financial centres research and analysis of the challenges facing the global economy in the Greater China region, including Hong Kong, Taipei and today. It maintains links with policy-makers and researchers around Shanghai, as well as the challenges and opportunities that shifting the globe to ensure that our independent analysis of global economic global financial influence may pose for Singapore’s role as an estab- issues translates into practical and timely policy insight on the chal- lished Asian financial centre. lenges facing the world economy today. The main themes include the changing world economy and the G20 framework, reform of the International competitiveness and growth international monetary system, growth of emerging market financial The past quarter-century has seen massive changes in the world centres, and international competitiveness and growth. economy. Trade integration and the globalization of value chains, with more and more manufacturing now taking place in emerging A changing world economy and the G20 framework economies, have created new challenges together with new oppor- In the wake of the recent financial crisis, the G20 has played an tunities. As we move forward into the next decade, it is critical to important role in facilitating international economic policy coopera- address the issue of how the industries of the future will look, and tion. It has yet to be seen, however, if the group can move beyond its which sectors/industries will lead future growth. roots as a crisis committee and play a more institutionalized role in International Economics is undertaking a series of projects to confronting the array of challenges facing the global economy today. examine the outlook for key global industries over the next decade. The International Economics team has focused its research to These include a series of research study groups on the changing explore the future prospects for the G20 and set out an ambi- industrial landscape and industry case studies identifying emerging tious schedule for international economic policy cooperation ‘global champions’. (Preventing Crises and Promoting Economic Growth: A Framework Chatham House is also partnering with the University of for International Policy Cooperation). In addition, current research Warwick’s Centre for Competitive Advantage in the Global Economy explores the role of G20 observer countries and those outside the (CAGE) to explore how markets, institutions, and public policy G20 process in international economic policy cooperation. interact to create and sustain competitive advantage in response to these global changes. Reform of the international monetary system The international monetary system is in flux – no longer meeting Recent publications: the needs of an increasingly unbalanced global economy, but not  Legitimacy vs Effectiveness for the G20: A Dynamic yet ready to move beyond the dollar as the world’s reserve currency. Approach to Global Economic Governance Current research explores the future of the international monetary Briefing Paper system, and assesses the prospects for a range of proposed reforms. Paola Subacchi and Stephen Pickford, October 2011 Apart from the work of the Gold Taskforce, recent research  Preventing Crises and Promoting Economic Growth: has focused on the prospects for a multi-currency reserve system A Framework for International Policy Cooperation (Beyond The Dollar: Rethinking the International Monetary System) Chatham House/CIGI Report and investigated China’s ambitions for the renminbi as an inter- Paola Subacchi and Paul Jenkins, April 2011 national reserve currency (‘One Currency, Two Systems’: China’s  ‘One Currency, Two Systems’: China’s Renminbi Strategy Renminbi Strategy). Briefing Paper Paola Subacchi, October 2010 Growth of emerging market financial centres  Aiming for New Vigour: The UK in the Global Economy As the epicentre of global economic growth continues to shift Briefing Paper towards emerging markets, Chatham House International Economics Vanessa Rossi and Jim Rollo, June 2010 has embarked on a series of studies into the specific challenges and  The Role of the US in the Post-Crisis Economic Order opportunities facing financial centres in emerging economies. Chapter in America and a Changed World: A Question of Recent work has focused on the strengths and weaknesses of Leadership the Gulf as a global financial centre (The Gulf Region: A New Hub Paola Subacchi, May 2010 of Global Financial Power) and the outlook for the Japanese finan-  Beyond the Dollar: Rethinking the International cial sector in the light of recent international trends (The Outlook Monetary System for Tokyo: New Opportunities or Long-Term Decline for Japan’s Chatham House Report Financial Sector?). Edited by Paola Subacchi and John Driffill, March 2010 40

www.chathamhouse.org Gold and the International Monetary System Rapporteur: André Astrow

Gold and the International Monetary System

A Report by the Chatham House Gold Taskforce Rapporteur: André Astrow

ISBN 9781862032606 Chatham House, 10 St James’s Square, London SW1Y 4LE T: +44 (0)20 7957 5700 E: [email protected] www.chathamhouse.org F: +44 (0)20 7957 5710 www.chathamhouse.org Charity Registration Number: 208223

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